Tomorrow OPEC convene in Vienna to discuss their strategy for oil supply.
OPEC was founded in 1960 by 5 middle eastern countries and now consists of 13 member states. These include Saudi Arabia, Kuwait, Iraq, Iran, Libya, Nigeria +more.
The meetings tend to occur semi-annually, however there can be exceptions to the two-a-year, such as a strategy meeting.
OPEC’s decisions at these meetings are closely watched by the markets, as the member countries operate one of the largest oligopolies on the planet. Tomorrow they will decide the fate of 72% of the world’s oil reserves and over 40% of daily barrel production – increasing to over 50% when the Russians are involved (although not an OPEC member, they have previously followed OPECs decisions to increase/cut supply). This therefore has implications on the price of oil, which filters in to much we pay at the pump, and also the FX markets, because oil is priced in dollars meaning a decision by OPEC to limit supply, and therefore increase the price, increases the demand for dollars – raising their value.
We therefore have two trades, FX and crude oil. In this post I wanted to see whether there is a pattern in the price of oil during the OPEC meetings, and if so, could we profit from it?
In the past year there have been three meetings. Thursday 2nd June 2016, Wednesday 28th September 2016, Wednesday 30th November 2016. The price of Brent Crude Oil (Brent) has been plotted in the graph below. Each meeting is based to 100, to allow comparability of movements.
The blue line is the June meeting, red line is September, green is November and purple represents the current meeting. I have plotted the price of Brent one week before the meeting and two weeks after. The time period is short, as I am looking at a short-term trading strategy. This graph is, of course, a drip in an ocean for the long-term investor.
What can we initially see? Prices tend to trade downward in the build up to a meeting, then on the day the price of oil has previously risen.
OK, so there’s a reasonable pattern but we shouldn’t jump to conclusions. Each meeting was very different.
November 2016 saw price increases of 8% on the day, 6% the day after, with a generally sustained higher price. June 2016 on the other hand saw a measly 0.64% increase on the day and a sustained price drop the following week. Why were both meetings so different? In November 2016 OPEC agreed on a cut, or more importantly, Saudi Arabia committed to one. As the price wobbled on the higher end the Russians also came in to support a reduced supply, causing the price to rise further. In June 2016 the meeting was a non-event, with a small mention of action needing to be taken but no commitments. Remember: a reduction in the supply of oil increases price, providing demand remains constant.
How do we trade tomorrow? A look at the contextual build up to tomorrow’s meeting is important. Brent is trading around 54$, this is up from $48 a week ago – a 12.5%+ rise. The market is already anticipating a reduction in the supply of oil. This is because, since announcing a cut in November, the price of oil has spent January to May trading downwards, not upwards. There are a few reasons for this: the higher 50$+ price initiated from the cut in November allowed U.S. shale producers to re-enter the market and push up supply, whilst a Trump presidency, and with it a policy of economic growth and blatant disregard for the environment, also signals a likely increase in shale gas production – pressuring oil downwards. A falling oil price does not fit with OPECs current commitment to reduce supply and increase prices, and therefore the base case for tomorrow is a cut in supply.
- The market has traded Brent up 12.5% in the past week, suggesting an expectation of tomorrow’s meeting yielding a reduced supply of oil. This suggests buying oil prior to the meeting, but we must be careful, as the market may have already priced in the rise expected from a cut.
- OPEC doesn’t cut, but discusses action. We could still see Brent rise in price, as seen in September 2016 when this occurred (see graph). However this could equally cause Brent to fall, as the market reverses its current pricing in.
- Brent from 2014 to 2016 saw a fall from $100+ to $28, partly due to Saudi Arabia political policy (lower prices damage U.S. shale, which was becoming an increasingly dominant market force). OPEC may therefore decide to keep supply at its current level for a while longer, so as to maintain their market dominance. Saudi Arabia breaks even at around 8$ a barrel, most shale gas in the U.S. rely on 60$+. By keeping shale unprofitable the U.S. companies are more likely to close shop.
If we look purely at previous movements, e.g. the graph above, I would be inclined to place a long bet on Brent tonight. However if market forces are efficient this movement would have already been recognised and therefore be unprofitable. We therefore have to place a guess on whether OPEC will cut, discuss cutting, or remain. With an average price change of 4.9%, tomorrow could yield a price of 56.59, a 264 point increase in todays price. Placing a spread bet of £1 a point you could be £264 better off.
Which ever decision you make, good luck.
UPDATE 25th May 2017
Option 2 occurred. OPEC decided to extend its current reduced supply levels for another nine months (e.g. decided to change nothing). Brent down 4% by the evening of the 25th. The market is pulling back from the priced-in expectation of further cuts.
**This post is written as an observation of market movements and the opinion of the writer solely. It should not be used as direct financial advice, which should be sought from your financial adviser.