OPEC Should Choose Its Words Very Carefully

Any support for oil prices also helps U.S. shale rivals.

Algiers or Vegas: It's tough to decide which offers better odds this week.

A cursory look at the headlines from OPEC's gathering in Algiers so far will tell you: Iran offered Saudi Arabia a deal on oil supply targets; Algeria says Saudi Arabia has offered a cutback; Russia's playing it cool on talking to anyone; and Venezuela is (as usual) hopeful something will come out of all this malarkey. And that was just on Monday morning.

Good luck trading that. Still, it's worth looking at where some others around the table are placing their chips. It might even be worth OPEC's time.

Hedge funds, at least, appear unconvinced anything tangible will come out of the Algiers talks:


Hedge-fund sentiment on Nymex light,sweet crude oil has swung up and down this year as hopes of OPEC action have waxed and waned. Net length fell sharply last week

Source: Bloomberg

Note: Net non-commercial combined futures and options positions.

Oil producers, meanwhile, at first glance appear to be a bit more optimistic:

The Producers

Commercial oil hedgers have been reducing their net short position over the past month

Source: Bloomberg

Note: Net combined futures and options positions for producers, merchants and processors.

One way of interpreting that chart is to think producers want to capture more of the upside as oil prices rise because, say, OPEC does something to juice them.

Another interpretation, outlined in a report this week from energy economist Phil Verleger, is less bullish. The producers' short position has come in a little, but only after a sustained expansion as they have sought to lock in cash flow to weather the storm (notice how that trend accelerated as oil collapsed through 2015). They have found willing buyers on the other side of this trade in the form of hedge funds and other speculators betting on a recovery -- a bet given some impetus by ultra-lax central bank policy.

Verleger, looking at the turn in producer positions as well as the sharp retrenchment in speculative length, wonders if those buyers are finally losing faith in the power of OPEC or anyone else to kickstart a rebound in oil prices.

If that were the case, a repeat of the Doha fizzle in Algiers could send oil prices into a tailspin as investors refuse to mop up excess barrels. On a medium-term basis, that would actually be good for OPEC, or at least its VIP members such as Saudi Arabia. Take away U.S. exploration and production companies' ability to hedge more of their future barrels, and you also take away their ability to keep creditors onside and tap equity markets, both of which have been crucial in slowing the collapse in shale production.

On the other hand, this would also be tantamount to signing a death warrant for Venezuela's economy. These sharp divisions, along with the unusually cloudy outlook for oil supply and demand after the last bull market, are at the heart of OPEC's struggles with itself.

One outcome being talked about is that OPEC doesn't agree to a definitive supply freeze or cut this week but does craft some words convincing enough to keep hopes alive for such a deal happening later this year. This would likely keep oil trading in the $40-ish range it's held since April, when the Doha talks failed.

Yet this would also, of course, help shale producers by keeping speculators ready to finance more surplus barrels heading into storage.

And this comes at a time when U.S. E&P companies are also getting a helping hand in the natural gas market -- which, don't forget, accounts for roughly half the output of the sector. As I wrote here, gas prices are enjoying a rare bit of cheer as excess inventories have come down and winter looms. This has had a profound effect on positioning in gas futures and options:


Investors have jumped from a net short position on gas to the highest net length in more than 2 years

Source: Bloomberg

Note: Net combined futures and options positions. .

It's harder to see on that chart, but that net short position on the part of gas producers is also the widest in about 2 years. E&P companies are taking advantage of what could be a brief rally to lock in some cash flow -- which would in all likelihood go toward paying off debt or producing more (higher-value) oil.

If the statement out of Algiers turns out to be a triumph of sentiment over substance, then OPEC will be taking one hell of a gamble.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Liam Denning in New York at ldenning1@bloomberg.net

    To contact the editor responsible for this story:
    Mark Gongloff at mgongloff1@bloomberg.net

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