Oil prices stable after producers agree to freeze

February 16, 2016 08:38 AM

Hope is such a bait, it covers any hook.

Oliver Goldsmith

Oil prices are stable after several key oil producers agreed to freeze oil output at a meeting on Doha, Qatar today. Saudi Arabia, Venezuela, Russia and Qatar agreed to freeze their oil output at January levels contingent on other producers also freezing their production. Neither Iran nor Iraq were at the meeting … two countries whose production has been steadily increasing.

Venezuela said more talks would take place with Iran and Iraq on Wednesday while the Saudi Minister said freezing production at January levels was an adequate measure and new steps to stabilize the market could be considered in the next few months according to a Reuter’s report.

The market reaction is currently muted with prices well off of the highs hit immediately after the meeting outcome was announced. As of this writing, Brent is up about 1.5% while WTI is higher by only 1.4%. On the surface it seems that both Iran and Iraq are going to be key players in whether or not this deal holds as they have both been consistently increasing their production.

Iran in particular may be reluctant to keep its production flat after years of restrictions due to sanctions. Reuters is already reporting that a senior Iranian official said Iran’s situation is totally different to countries that have been pumping oil at high levels in recent years. Sounds to me like Iran is going to be a hard sell to convince.

In addition, even at current production levels supply will still be outstripping demand through most of the year. However, the magnitude of the surplus will begin to narrow as non-OPEC production declines. That said, if prices stage a strong recovery the expected decline in U.S .shale oil production may not turn out to be as large as currently projected.

So once again the market has a new potential deal with contingencies to digest along with a question mark as to how the whole deal will be monitored. Even if Iran does agree to freeze its output will they cheat? They did a good job of pushing oil into the market while the sanctions were in force. In addition Russia has a track record of agreeing to something to only continue to do whatever they prefer to do. Finally, will a freeze truly be enough to result in oil prices entering into a sustained upside rally?

The above said, I view this deal as a step in the right direction for the producers if the group of 4 are able to garner support from the rest of OPEC (in particular Iran and Iraq) as well as other key non-OPEC countries that have participated in joint OPEC/non-OPEC production deals in the past. For the short term the announcement of this deal is likely to keep a floor on prices and possibly push some additional shorts out of the market especially if tomorrow’s meet with Iran and Iraq is successful.

It is too early to decide if this will be a deal that does not collapse very quickly. For now the announcement of this deal could increase the likelihood of further short covering in the short term. Whether this is a good opportunity to reset shorts at higher levels remains a question mark. I think the deal is suggesting a weakness in Saudi Arabia with an opportunity for them to enter into a face saving arrangement to move away from their failed market share strategy. A deal such as this deal is not a cut (yet) but could eventually lead to a cut in production down the road.

I would once again suggest that buy side hedgers begin to have a plan ready to go to protect against upside price risk. Options strategies may be the best approach until it is clear if this is going to result in a strong upside price recovery. Options strategies will not only protect against upside price risk but also allow for participation to the downside should this deal collapse.

A lot of questions will be circulating around the media airwaves which is likely to result in volatile trading for the next few sessions at a minimum. This deal or potential deal will be the main discussion point in the global markets and discussions and comments about the deal will impact the short term direction of prices.

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