In an historic day for the oil market, the OPEC members met in Vienna in a closed door session and reached an agreement on 1.2 Mbpd of production cuts. Combined with a non-OPEC pledge to cut 600kbpd (including 300 kbpd from Russia), we will begin to see inventories slowly diminish.
Yet the language leading up to today was pessimistic. The Saudi energy minister Khalid al-Falih repeatedly stressed that even without a deal the market will balance itself in 2017. In any negotiation, the party who appears to care least often walks away with the most, so this is just the sort of tough talk one might expect from the Saudi energy minister. Meanwhile the Iraqi and Iranian representatives held firm and white-knuckled onto zero cuts. The Russian energy minister, Nakow, announced that he would skip the OPEC meeting, explaining that Russia would not make any commitments until OPEC reached an internal accord.
We entered the day with considerable uncertainty about the outcome. Then when word of a deal began leaking out of the meeting, the Brent futures lept 7%, and more strikingly, the share prices of US producers (and oil service companies) rocketed up by 10 – 11% on the open. These companies are acutely sensitive to the difference between a $40 barrel and a $50 barrel. The suddenness of the move was evidence that the entire market was taken off guard.
We managed to jump into to the mix and increased our length in BP, Statoil, Transocean, and Schlumberger. Near the end of the day we monetized some of the shares’ gains by selling short-dated OTM calls (with rich vol) covered by our increased length.
Chasing market share has all along seemed like a sub-optimal strategy for the Gulf states. They need to maximize revenue over the next 20 years and ignore any production targets. Saudi Arabi will profit more from producing 7 Mbpd at $100 then 10 Mbpd at $50. In a world of extreme uncertainty over political-environmental policies, 20 years of strong demand is all that should be banked.
Still another reason to start draining the inventories now is that the future buyers of Saudi Aramco shares will pay a premium for a stable rising barrel price. A higher valuation demands a higher price per barrel of oil.