OPEC Production Cut: Should We Have Been Surprised?

The big news last week was that the Organization of the Petroleum Exporting Countries agreed to a production cut.

Oil prices shot off after the OPEC meeting in Algiers turned from typical inaction to surprise action.

But should we have been surprised?

I mean, I am surprised at what seemed like an 11th-hour agreement. And it seems the market was just as surprised … otherwise oil wouldn’t have shot up almost 6% on the news.

But in hindsight, I’m wondering if we should have been surprised.

After all, it was the perfect opportunity for OPEC to take action.

Why? Three reasons.


First, they acted precisely because no one thought they would. The impact on markets is clearly much greater if investors and traders are able to fully discount the action.

Second, they acted because they had room to act without actually having to change much.

You see, the production cut isn’t really a big deal. But it feels a lot bigger since it was unexpected. But the agreed-upon 700,000 barrels-per-day of output that will be "eliminated" is only a dent.

In fact, it barely eclipses the recent production increase that’s occurred since the last OPEC meeting tabled the production-cut idea in Doha.

OPEC production has risen 13.5% since OPEC’s last meeting in Doha, Qatar, ended on April 18.

Of course, the outages in Libyan and Nigerian oil production are clamoring to be brought back online. This alone almost renders the production-cut deal meaningless.

And let’s not forget that Russia — not an OPEC member — just added 400,000 bpd of production from August to September. (I suspect this data is not incorporated into the following chart.)

What does this mean?

Well, it means the price of crude oil has the potential to disappoint in a big way.

The EIA has data available through June 2016 of Russian oil production, which as you can see has been rising steadily over the past five years.

This isn’t to say a rethink of the price rally after the meeting is inevitable. But it is to say that when the market gets a moment to digest the actual impact that such a production cut will have on still bearish fundamentals, the optimism could easily (and quickly) fade away.

As for the third reason, well, it’s all about restoring OPEC’s street cred.

In the days before the deal was struck, a Russian heavyweight essentially called out OPEC as not having any influence on the oil market anymore.

Rosneft’s influential chief, Igor Sechin, a close ally of Putin, has said internal differences were killing OPEC and its ability to influence the market.

Indeed. It has felt a little bit like the tail wagging the dog with OPEC in recent years.

Now, the perceived lack of influence may be best explained by looking at the relationship between Saudi Arabia, OPEC’s top dog, and the United States. Saudi Arabia’s unilateral decision-making within OPEC may have very well been dictated by U.S./Saudi foreign policy interests in the Middle East.

But now Saudi Arabia is feeling the pinch.

Two-thirds of their population is employed by the public sector. And the Saudi government just announced it will enact a range of salary cuts, allowance cuts and a freeze on wage growth. Those things accounted for 45% of government spending in 2015.

Needless to say, Saudi Arabia is just as ready to see increased petrodollars flooding into their economy as every other OPEC nation.

The takeaway now is how traders will respond to:

1. A shortage of details. (The full agreement will not be ironed out until an official OPEC meeting in November.)

2. The significance of the size of the cut. Production is currently estimated at 33.2 million barrels per day. The cap allegedly agreed upon is between 32.5 million and 33 million bpd.

Again, that doesn’t seem all that significant to me. But hey, I’m no oil minister trying to resurrect the cartel.

Just be careful jumping into oil right now.

Do right,
JR Crooks

“JR” specializes in trading commodities, currencies and options. He has spent nearly 10 years analyzing financial markets and writing about global economics. JR honed his trading techniques and global-macro worldview alongside his father, Jack Crooks, at Black Swan Capital. JR also…