OPEC unlikely to cut production ceiling; lower prices may prevail

Crude oil traders are now in wait-and-see mode as the OPEC mulls a production cut. Yesterday, a meeting between some large oil producing nations including Russia, Mexico, Venezuela and Saudi Arabia failed to find a solution in terms of production cut. In truth, an agreement was never likely to be reached prior to the actual OPEC meeting on Thursday anyway. The situation is really complex this time with the likes of Iran, Iraq and Libya wanting to be exempt from a possible production cut due to recent supply outages in those countries. Crude oil is thus likely to be extremely headline-driven until the conclusion of the OPEC meeting tomorrow, so price spikes could be quite common as traders respond to fresh comments from various OPEC oil ministers. So far, their comments have supported the view that the OPEC is unlikely to change the output quota. The group should "monitor the market carefully"; the oil market "will stabilize itself eventually" or that it “will fix itself ultimately" were among some of the recent remarks made by oil misters of Iran, Saudi and UAE respectively. As a result, traders are sceptical that the cartel’s current production ceiling of 30 million barrels of oil per day will be reduced at this meeting. Indeed if the OPEC were to trim the production limit, it will therefore concede more market share to shale oil producers, so it is not in the best interest of its members in the long term. In fact, for some larger OPEC members like Saudi, this short-term supply glut and therefore lower oil prices may be to their benefit from a longer-term point of view as this will undoubtedly put pressure on smaller and inefficient oil producers. Even if the OPEC agrees to cut production, it is not like all of the members will necessarily stay true to their word.

On a side note, this is a classic case of the Game Theory. The best outcome would be for the OPEC to cooperate. But the risk of a defect among the cartel is high, so the best strategy from an individual player’s point of view is to produce as much oil as it can. Not only that, the cartel is also facing stiff competition from non-OPEC countries like US thanks in part due to the boom in shale oil production. For that reason, the OPEC is unlikely to lower the production target on Thursday. This view is also shared by my colleague Kathleen Brook – click HERE to see her commentary. Thus lower oil prices may prevail until such a time that the growth in demand picks up markedly. At the moment, there is no sign of that happening with economic data from the major economies coming in weaker than expected. Even data from the US surprised to the downside today, most notably the weekly unemployment claims and housing market numbers, while the usual crude stockpiles report confirmed that the glut in the US is growing and demand is subdued.

As things stand, WTI looks set to drop toward the next psychological support at $70. It is currently hovering tightly above support and this month’s low of around $73.30. Although the RSI has created a positive divergence, which suggests the bearish trend is weakening, fresh selling could result if the OPEC agrees not to cut production. Traders should also watch the Fibonacci extension levels around $72.00 (127.2%) and $70.45 (161.8%) for potential support. Some of the short-term resistance levels to watch include $74.45, $75.50 and $77.80. For Brent, a drop to $75 a barrel looks likely now.

Figure 1:

Source: FOREX.com. Please note this product is not available to US clients.

Figure 2:

Source: FOREX.com. Please note this product is not available to US clients.