OPEC increases output cuts
The Saudis want a higher price
Iran continues to be a problem
Twice each year, the oil ministers of the international cartel gather in Vienna, Austria, to decide on production policy for the next six months. On December 5, the meeting was only open to members, but on December 6, non-OPEC members joined the discussions. In the past, the members of the cartel made all of the decisions. Since 2016, Russia has become a dominant force when it comes to output policy. The United States, Saudi Arabia, and Russia are the world’s leading crude oil-producing nations. Together, they produce more than the members of the cartel.
The marriage of convenience between OPEC and Russia began after the price of crude oil fell to a low at $26.05 per barrel in February 2016. Around that time, Brent crude oil declined to a low at $27.11. The Russian oil minister Alexander Novak and President Vladimir Putin participated in the production cuts along with the cartel that lifted the price from the bearish abyss. Russia’s influence within OPEC is an essential component of its apparent strategy to expand its sphere of influence in the Middle East and throughout the world.
Last week’s OPEC meeting had to wait until Friday, December 6, for the Russians to approve the cartel’s production plans for the first half of 2020.
The United States Oil Fund (USO) and the United States Brent Oil Fund (BNO) are the two ETF products that follow the prices of the pricing benchmarks for the energy commodity.
OPEC extends output cuts
OPEC told the world that it would reduce daily output by another 500,000 barrels per day, bringing the total reduction to 1.7 million. Additionally, the Saudi Oil Minister said that his country would extend a voluntary cut of 400,000 barrels. The net impact of the OPEC meeting will be a 2.1 million barrel per day production cut starting in 2020. The cartel will re-evaluate its production policy in early March.
The ongoing trade war between the US and China continues to threaten the global economy and weighs on the price of crude oil. Protectionism, along with US daily output at a record high 12.9 million barrels per day, caused OPEC to take action. Had the cartel not increased its output cut, the price of oil would have likely declined. In the aftermath of the meeting, nearby WTI and Brent crude oil futures posted marginal gains.
The daily chart of January NYMEX WTI crude oil futures shows that the price closed last week at over $59 per barrel, a new short-term high. The energy commodity put in a bullish reversal trading pattern on Friday, December 6, in the aftermath of OPEC’s policy announcement. Nearby Brent futures were above $64 per barrel on Friday, as both oil benchmarks moved to their highest prices since mid-September.
The Saudis want a higher price
One of the motivations for Saudi support for a deeper production cut at the winter OPEC meeting is this week’s IPO of Aramco. The Saudis are selling shares in its state oil company on the local exchange at a valuation of $1.7 trillion. The Aramco IPO is the largest in history and will raise over $25 billion.
In 2018, Saudi Arabia attempted to bring Aramco to market with an IPO on the US stock exchange. However, the plans fell apart over a disagreement over the value of the world’s most profitable company. Crown Prince Mohammed bin Salman believes that the valuation should be $2 trillion or higher, while most financial institutions valued the oil company at under $1.5 trillion. Aside from its very high profit margins, shareholders face many risks when it comes to investing in the company. The regulatory and reporting environment in Saudi Arabia can be suspect. The drone attack on Aramco’s production in mid-September temporarily knocked out 50% of the company’s output until the end of that month. The event was a reminder of the political volatility in the region that could impact earnings. Additionally, the world has not forgotten the murder of Saudi national and Washington Post journalist Jamal Khashoggi in 2018 at the hands of Saudi security forces. Khashoggi was a critic of the Crown Prince and royal family.
The latest move by OPEC that will keep the price of oil stable provides a boost for Aramco’s profits and the ability to sell shares of the oil company.
Iran continues to be a problem
Meanwhile, US sanctions on Iran continue to choke the Iranian economy. The theocracy in Tehran has cracked down on growing protests in the nation, resulting in reports of more than 1,000 deaths. The ongoing political tensions within Iran as well as between the theocracy and the US, Saudi Arabia, and Israel continues to threaten peace in the region. Any further hostilities that cause problems with production, refining, or logistical routes in the Middle East could cause price spikes to the upside in the oil market, as we witnessed in mid-September.
Last week’s OPEC meeting was another reason why the price of crude oil should continue to find support over the coming weeks and months. Brent outperformed WTI futures in the aftermath of the cartel’s decision, but both benchmark prices edged higher at the end of last week to new short-term highs.
The United States Oil Fund LP (USO) was trading at $12.37 per share on Tuesday morning, up $0.04 (+0.32%). Year-to-date, USO has gained 3.00%, versus a 18.21% rise in the benchmark S&P 500 index during the same period.
About the Author: Andrew Hecht
Andrew Hecht is a sought-after commodity and futures trader, an options expert and analyst. He is a top ranked author on Seeking Alpha in various categories. Andy spent nearly 35 years on Wall Street, including two decades on the trading desk of Phillip Brothers, which became Salomon Brothers and ultimately part of Citigroup. Over the past decades, he has researched, structured and executed some of the largest trades ever made, involving massive quantities of precious metals and bulk commodities. Aside from contributing to a variety of sites, Andy is the Editor-in-Chief at Option Hotline.