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Three Things You Should Know About OPEC’s Oil Deal

by Alahdal A. Hussein
OPEC Oil Deal

By now, everyone knows that OPEC has settled on the outline of an agreement to cut its oil production for first time since the height of the global financial crisis in 2008. The agreement details will be finalized during OPEC’s next meeting in November, however what is clear right now is that the terms of the agreement will include cutting the cartel’s oil production from around 33.24 million barrels per day to between 32.5 million and 33 million barrels per day. Despite the fact that oil prices have responded positively to the news and spiked more than 7 percent settling above $50/bbl, the deal does not look like what it really is. And here are three things that you should know about OPEC’s oil deal.

What You Should Know About OPEC’s Oil Deal:

1- The oil deal is engineered to prevent oil prices from falling further not to push them up. This point will become more clear after oil prices reach to $50/bbl. The Saudis -the ones who engineered the market share war- know very well that prices above $50/bbl will bring back their rivals -shale oil producers. In fact, this has been tested many times in the past few months. Once oil prices reach to $50/bbl, we see a sharp increase both in U.S. rig count and its oil production. This tells us that OPEC wants to prevent oil prices from falling further, but at the same time they will not allow it to move higher than that level. This will be clear in the next few weeks. If oil prices started heading to high levels close to $60/bbl, OPEC’s members will start spreading some negative news which will bring prices down again.

2- Signing the oil deal means that Saudi Arabia and OPEC’s members backing its market-share war against U.S. shale oil producers are accepting defeat. There is no other translation for this oil deal other than this. If Saudi-led OPEC sealed the deal this coming November, then two years of suffering will go for nothing, and shale oil producers will be the one winning the game and forever. This point is very critical for the Saudis, because if they blink in this market-share war which they have started two years ago, they will not only lose their market share, but they will also make shale oil appears strong and attract more investment in the near future.

3- If OPEC’s oil deal is sealed, and the cartel cut its oil production as stated, the next oil prices fall will be caused by the return of shale oil producers. Regardless of the fact that it is highly unlikely that OPEC will really agree on any production cut, if that production cut was surprisingly implemented and OPEC really cut its oil output, then we will see oil prices rising to $60/bbl. At that level, many shale oil producers will return back to the market, more drilling activities will begin, and production will increase as well in a fast pace. That means, the outcome of OPEC oil deal will be reducing the cartel’s oil production by roughly between 200,000 to 700,000 bbl/day, yet on the other hand, it will cause a return of much more oil production from U.S. shale oil producers.

It is very clear that Saudi-led OPEC is facing a delicate situation. They can seal a deal and cut oil output, but that will make them lose their market-share and at the same time, it will allow the return of their rivals. But they also can do nothing, and result in oil prices falling back below $40/bbl. They can’t do any of the above, therefore they chose another way of playing which I call the emotion game. They have been playing this game since the beginning of this year.

It is all about spreading optimism, giving the oil market a hope, which in this context is spreading news about production cuts. This hope supports oil prices and prevents them from falling further. But at the end of every round in this game, no action is taken. We are now in “round 3” of OPEC’s Emotion Game, and when November comes, you will all see that no action is taken, and prices are kept around $50/bbl.

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