Keith Underwood 13 Comments

OPEC – Organization of Poor Examples of Coordination

Ho hum. The latest agreement out of OPEC is a proposed reduction of 800,000 barrels per day. Handily, the actual specific details of the reduction has yet to be finalized and that leaves who, what, where, when, and how to be sorted in November. Let’s see what can be agreed in a warring region of the world where trust is at a low and adherence to production limits are historically slippery for some.

 

800,000 may be an overly optimistic cut given that Iran has only just agreed to join the discussion. They have refused, on several previous attempts; to even show up to talks. Other oily actors like Russia seem intent to play ball by their own rules, so don’t plan for anything that doesn’t benefit them. As a non-Opec member they are likely to not participate in a reduction. Even if they did would you believe them?

 

Should Opec succeed in their production cut theatrics and sustain a higher price of $55-$60 per barrel, the higher oil price will encourage shale producers to dust off the projects that were uneconomical while oil was below $40-$45 per barrel. The higher the price goes the more potential supply realized by projects left idle before.

 

So what’s this have to do with the foreign exchange market you ask? Well, while all this hoopla is going on we will see increased headline trading (quick, sharp, short movements) in spot FX with currencies that are correlated to the price of oil. Correlation is the generalized movement of one asset versus another (either positive or negative). So if oil increases in value you might see an increase or strengthening of the Canadian dollar (oil exporter) versus a country that is a consumer (importer) of oil such as the European Union or Japan. Other exporters that could also benefit are Russia, China, Brazil and Mexico.

 

Oil has been trading sideways all year long (see chart) and anytime you have a prolonged period of consolidation or range trading, the breakout move (out and away from the previous range) will be that much greater and volatile. Think of a Jack-in-the-box toy that is wound and wound and wound until it pops. This is typically what happens the longer that a tradable asset stays within a predefined or preexisting range. Oil could be in this type of situation, but so too are many other tradable assets, due to concerted government intervention in the interest rate markets keeping rates low or even negative, for longer. See ‘Negative Interest Rates: A Disincentive to Risk’ for my pessimistic views on negative rates.

Trading range oil 2016

As such, the inflection points or ranges that has developed over months and years will ultimately break and bring with it severe liquidity shortages and violent gapping movements. Could OPEC produce a breakout moment with a viable and substantial agreement to cut production? My opinion is that they could, but we have been down this path many, many times before and I can’t really get that excited about a re-run where there is no real emergency for the cartel members to act. Expect a bland communiqué that expresses dismay at the present low price of oil, the need to keep the global economy growing (to use more oil) and production cuts that will be in the best interest of the cartel.

 

keith@underwoodfx.com 

Traded Markets Intelligence

UnderwoodFX.com