The OPEC Deal Is Facing Its Biggest Test
Producer group’s cuts strategy faces first ‘proper challenge’
Technical signals reflect size of task faced by producers
OPEC’s strategy to balance the oil market and bolster prices is facing its biggest test.
The producer group is aiming to revamp the market by eroding a crude inventory surplus that’s depressed prices since 2014. A deal to cut output announced at the end of November, intended as a catalyst for trimming global stockpiles, had the side-effect of triggering a surge in U.S. production and a jump in the nation’s inventories to an all-time high. That’s prompted crude to give up a chunk of its post-deal gains.
With the focus now shifting to what the Organization of Petroleum Exporting Countries will do next, here are six charts indicating which way the oil market could be starting to turn.
WTI and Brent sank by the most in more than a year on Wednesday, with U.S. crude subsequently falling through $50 a barrel for the first time since December. “The market will be in limbo for a few days, the question is how low can it go,” said Richard Fullarton, founder of London-based commodity hedge fund, Matilda Capital Management. “There’s been so much effort by OPEC and non-OPEC to show high compliance, that it would be strange for it to fall apart now.”
The aim of the supply cuts has been to turn the oil market upside down into a structure known as backwardation. That means prices in the short-term are at a premium to those further out, swelling OPEC revenues while limiting those of its competitors. However, the difference between WTI prices for this December and next has slumped back into contango, while the the nearest 9 Brent crude contracts are also now in that market structure. “Everything has been put in doubt,” Olivier Jakob, managing director of consultancy Petromatrix GmbH, said by phone. “It shows that the market is still very fragile.”
3. Options Bearish
Options markets are also turning increasingly bearish on future prices. The difference in the cost of bearish and bullish oil contracts, known at the skew, has moved sharply in favor of falling prices in the past two days. That follows the second highest volume of options traded ever on Nymex’s WTI contract on Wednesday, as investors hunted out near-term protection against declining prices. A slump below last November’s price levels would be the last thing OPEC planned for when it agreed to cut supply. This week’s price drop represents “the first proper challenge to OPEC and its resolve to cut production,” said Ole Hansen, head of commodities strategy at Saxo Bank.
4. Sellers Return
The slump in prices may also be attracting more short sellers, a further dent in OPEC’s bid for higher prices. The number of WTI contracts outstanding rose back to near record levels as prices fell on Wednesday, often a sign of new bets on falling prices. “The production cuts story also isn’t biting as members of the agreement expected,” said Gerrit Zambo, trader at BayernLB. “For Brent, $50 a barrel should certainly be a good support. Maybe the next big mark is at $45 in WTI, but that’s quite a long way.”
5. Technical Trouble
And if all that doesn’t give OPEC enough to think about, there’s also the technical picture. Brent and WTI settled below their 50-day and 100-day moving averages on Wednesday, and fell further toward their 200-day markers on Thursday. “Maybe the herd is turning,” said Tamas Varga, analyst at PVM Oil Associates. “I think this is technical selling.”
6. Too Far, Too Soon?
While crude has been in free-fall through the major moving averages, gauges of momentum are starting to signal some respite. Both Brent and WTI closed below their lower Bollinger bands on Wednesday, and remained below those markers Thursday, a signal that the price slump may be overdone. WTI is set to close in oversold territory on the Relative Strength Index, with Brent also near that marker.