The market setup has reached a binary turning point:
1) Oil is priced for OPEC cut extention well into 2018, 2) investors anticipate stock draws with strong product demand and 3) the options market implies “explosive” Middle East related headlines (via funds large long positions on the $80 & $85 strikes).
The record-smashing long investor positioning, as we close in on November 30th, is a testament to the strength of the bullish narrative and how portfolio flows gushed to enter the front of the curve. Memories of the May market selloff may well be the strongest argument yet for this not to repeat.
In this report we look at consensus calls for the OPEC meeting and share our trading views.
SCENARIOS AHEAD OF THURSDAY, 30 NOVEMBER, OPEC MEETING
Consensus expectations suggest that the upcoming OPEC meeting should be nothing short of a yawner, with an automatic rollover of production cuts to the end of 2018. If it were not for the accumulation of record net length across the oil complex, we might agree. As it is, the current setup is for a binary outcome.
A good analogy for the current market setup is 4Q 2010. Similar to now, investors struggled to make money as oil traded within a $10-15/bbl range but with significant price moves characterized by the flush out of net long speculative positioning (sound familiar – May 2017?).
At the same time OECD stocks in 2010 were falling at a dramatic pace as the global macro environment started to normalize following the 2008 financial crisis and significant central bank and OPEC intervention.
Net speculative length in WTI (at the time information was not collected on Brent) increased to a new record high as investors doubled down on further stock draws and the rollover of OPEC production cuts (déjà vu all over again).
OPEC delivered in December 2010, with the rollover of production cuts. What followed, shortly thereafter, was the beginning of the Arab Spring and the eventual collapse of Libyan production, which sent oil prices to $100/bbl where they stayed for more than 3-years. There is a growing similarity with potential geopolitical risks rising in the Middle East, particularly Saudi Arabia, but also Venezuela.

Brent setup similar to 2010 | Positioning “washout” mid-year with Q4 rally
Obviously, there are two big differences versus 2010 and the present situation. The first is US shale and the second, Russia.
In 2010, US shale was just starting to kick off and expectations of a boom were nowhere to be seen. In fact, if OPEC were to look back, the December 2010 decision to maintain production cuts sealed OPEC’s fate and fuelled the US shale boom (low interest rates boost from Western CB alchemy) from which the oil market is still trying to recover.
Is this meeting a “Groundhog Day” moment for OPEC?
Let’s not underestimate shale. However, that’s hard to do these days with consensus estimates for shale growth ranging between 1-1.2mb/d in 2018. Strong annual growth of 850 kb/d is forecast for the next 5-years. While shale was a big unknown in 2010, every analyst currently has close to a best case scenario built in for shale in current consensus forecasts. The real elephant in the room is Russia.

Russia overtakes Saudi on oil sales to China
THE ELEPHANT IN THE ROOM IS RUSSIA, NOT US SHALE
Russia has been a key player in balancing the oil market. In fact, it was not until Russia fully co-operated with the Saudi led OPEC/NOPEC cuts with its 300 kb/d cut that the oil market really started to clean up.
– CHART BELOW – highlights front month Brent oil prices based in Russian Rubles. Economic incentive was a clear driver of Russia’s co-operation with Saudi Arabia in late 2016. However, with Ruble based oil prices near 2014 highs, Russia has no economic incentive to extend production cuts for all of 2018.
Russian oil companies would essentially see it as subsidizing US shale growth and rightly so (shale production estimated growth at >1.0mb/d 2017/2018).
There is chatter that Saudi Arabia’s first ever official visit to Russia by a Saudi monarch in October and subsequent arms deals (reportedly >$3bn) may have temporarily bought OPEC some time. We give little value to this. Similar deals, such as Saudi Arabia’s Public Investment Fund plans to invest $10bn in Russia over the next 5-years starting in 2015, have amounted to very little in terms of hard dollars.

BRENT in RUB | Above 5yr average
In our opinion, there seems little economic incentive to give up hard “petro-dollars” in lieu of the promise of military contracts that may not materialize.
Russia would remain diplomatic and are unlikely to denounce Saudi Arabia and the extension of the OPEC cuts publicly. Rather, we estimate that exports would start to grind higher and quotas starting to be breached on a regular occurrence.
Simply put, what was a strong economic incentive for Russia, is no longer there. Realities means less incentive for Russia to be aligned with Saudi Arabia’s goals.
Russia subsidizing US shale growth may be the straw that breaks the camel’s back. Without Russia on board, OPEC production cuts are unlikely to hold. The key reason being Russia’s increasing market share with China – SEE CHART WITH CHINA IMPORTS –
We outline our expectations for the OPEC meeting:
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