Oil’s volatile year: what to watch

All pumped up: oil and gas producers are bracing themselves for an eventual fall in demand © Getty

Since the production cartel Opec provisionally agreed to work towards cutting oil output in late September, prices rallied to a year-high of close to $54 a barrel before slipping all the way back to almost $45.

As the group attempts to hammer out a deal to finalise the implementation of the cut ahead of its next official meeting on November 30, here are the things that should define the next move in a volatile year for the crude price.

Opec or No-pec

What Opec agreed in Algiers in September was at once perfectly simple but also fiendishly complex.

From a collective production level well above 33m barrels a day, the group wants to reduce output to 32.5m b/d, or slightly higher if output disruptions in some members come to an end. A reduction is needed to soak up a persistent supply glut that has hammered prices as well as the budgets of Opec members.

While the target for the cut is relatively static, the baseline has swung around. Some members have raised production, taking total Opec output to about 33.8m b/d, in effect leaving the cartel with a bigger cut than they first envisaged in Algiers.

The market is now hoping that Saudi Arabia’s desire for less production will see it corral its Gulf allies to make the lion’s share of the cuts, and get every one else onboard, including regional rival Iran. That could be followed by support from non-Opec members like Russia pledging to freeze production — albeit at a record post-Soviet level well above 11m b/d.

Paul Horsnell at Standard Bank argues the consequences of failure to finalise a deal, plus the political capital already used trying to agree one, provide a strong incentive for an agreement in Vienna this month.

“We think that the market has written off the chances of a deal too quickly,” Mr Horsnell says. “Opec often reaches agreements in a fairly noisy way and, like many organisations, it rarely reaches a definitive deal before a deadline.”

Light, sweet surprise

Part of the challenge facing Opec is the surprise recovery in output from two members, Libya and Nigeria. Both countries are expected to be exempt from any cuts because of the problems they face with internal conflicts. The combined increase from the two Opec members — at about 600,000 b/d — is equal to more than half the cut the producer group had hoped to implement.

They also produce lighter, sweeter crude grades, which can have an outsized influence on international marker Brent. That’s down to their similar quality to the benchmark and relative geographic proximity. Overall, the net effect is to increase pressure on Opec to find a way to cut output meaningfully.

“Opec does not have to do very much to both balance the market and scare the shorts,” said Citi analyst Seth Kleinman. “The question is whether even this limited ask is within reach,”

Libya’s output has roughly doubled from 290,000 barrels a day in the middle of September to almost 600,000 b/d. In Nigeria, militant attacks have continued to hamper production, but at one stage this month output reached more than 2m b/d, recovering by about 500,000 b/d since the Algiers meeting.

Hedge fund doubts grow

Bets by hedge funds on the oil market has been closely correlated with the price of crude this year. With little tightness in the physical market, arguably more power has been handed to those prepared to take a position on the future outlook.

In the immediate aftermath of the Algiers deal, hedge fund managers from Mayfair to Connecticut seemed prepared to buy Opec — and particularly Saudi Arabia’s — position that cuts were coming. By early October, they had accumulated a combined net position across Brent and US benchmark West Texas Intermediate that was the biggest on record, equal to more than 650m barrels of crude, or a week’s worth of global demand.

However, since then many funds have grown nervous given a concrete deal is yet to emerge. Brent net longs — the difference between bets on rising and falling prices — have dropped by 50m barrels. In WTI, the reduction has been almost 70m barrels.

With prices back at $45, are they ready to buy in again ahead of the meeting?

US producer hedging

The bounce in the price after Algiers provided a lifeline to US shale oil producers who were able to lock in prices for the next two years of between $50 and $60 a barrel, a lofty enough level to keep plenty of American producers operating.

That should slow the decline in US oil output, which has declined by about 10 per cent since early 2015.

For traders watching the price, that might also mean there are fewer counterparties to sell into any rallies from the $45 a barrel level given producers are already hedged. If Opec does organise a substantive deal that could pave the way for a fast move higher.

“It is likely that many shale players took the opportunity provided by higher prices over October to lock in a portion of next year’s production when the b

ack-end of the WTI forward curve temporarily rose,” say analysts at JBC Energy in Vienna. “[That’s a] possibility that no longer exists.”

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