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Don't Be Fooled By This Oil Rebound Rumor

By Matthew DiLallo - Sep 5, 2015 at 12:20PM

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OPEC op-ed baffles insiders as it seemed to hint at a policy shift that surprised not only the market, but OPEC insiders.


Photo credit: Flickr user Anders Sandberg. 

Oil prices have gone on a ballistic surge over the past week and a half. Crude rallied from its recent bottom of just over $38 per barrel in late August to a peak this week closer to $50 per barrel. One of the catalysts leading this surge is a market rumor speculating that OPEC would soon shift its policy from protecting its market share to improving the oil price by leading a production cut. It's a rumor that was sparked by comments made in a publication by its own public relations team, however, it's a rumor that OPEC insiders say the market should ignore because, as it has said before, it won't cut alone.

Reading between the lines
On Monday the OPEC Bulletin, which is a magazine published by the group, was released and contained wording that had the market hopeful that a coordinated production cut was a growing possibility. In a commentary entitled "Cooperation Holds the Key to Oil's Future" OPEC wrote that,

As the Organization has stressed on numerous occasions, it stands ready to talk to all other producers. But this has to be on a level playing field. OPEC will protect its own interests. As developing countries, its Members, whose economies rely heavily on this one precious resource, can ill afford to do otherwise. Cooperation is and will always remain the key to oil's future and that is why dialogue among the main stakeholders is so important going forward. There is no quick fix, but if there is a willingness to face the oil industry's challenges together, then the prospects for the future have to be a lot better than what everyone involved in the industry has been experiencing over the past nine months or so. Only time will tell.

What the market read is that OPEC is willing to reduce its oil output if other non-member nations, namely Russia, will reduce theirs. However, that is much easier said than done, which is why a number of OPEC insiders have come out recently to say that what was written is nothing new. So, any short-term oil price jump based on speculation of a policy change is a foolish move by oil traders.

The Russian response
Having said that, Russia has said that it is willing to continue talking with OPEC about ways to stabilize the oil price. It has already met with some OPEC members in the past, but those meetings didn't end with an agreement on coordinated cuts. However, as oil continues to remain weak, Russia remains open to more dialog.

The problem is that Russia just can't shut off its oil pumps like other OPEC nations can because its technology is different as its oil is located in much colder climates. Further, Russia's oil industry is a bit more fragmented than that of OPEC nations as it has a number of independent oil companies that have shareholders and banks that they need to answer to. As a result, the best Russia might be able to do is keep its production from growing, or offer a small production cut, but that has more to do with economic reasons as it would pull back investments and not shut off any oil pumps. That's a problem for OPEC as it doesn't want to bear the brunt of the cuts.

OPEC has come this far, so it likely won't cut its production until other producers reduce theirs. That's simply not likely to happen anytime soon as oil companies are reluctant to shut off the pumps to their cash flow machines. It's why OPEC wrote that there are "no quick fixes".

That being said, production declines will come naturally as the decline rate of an oil well never sleeps because oil reservoirs deplete. In recent years the industry has invested heavily in new wells to not just overcome this decline, but to more than meet growing demand, However, the oil price plunge has really slowed investment rates dramatically. Because of this many parts of the world are seeing the decline rate take hold as production has plateaued and is even slightly declining in places like the U.S, Mexico, and the North Sea. As those declines continue to take hold over the next year it should help to better balance supply with demand. That was OPEC's end game all along, and it isn't likely to give up until it forces weaker producers out of the market. It may be worried, but it's not ready to give in.

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