Watch the Russian Ruble for clues on navigating OPEC dialog

Original Post on LinkedIn

The Russian Ruble has been weakening in sync with WTI & Brent crude oil prices.

This weakening of the Ruble vs the US Dollar occurred despite the relative strengthening of the Euro after a weaker-than-expected stimulus package being announced this week, highlighting the dominance of oil price movement and political relations with Turkey over general macroeconomic flows. 

There were also false rumours floating about Vienna yesterday about discussions of a potential 1 million barrel per day cut, but the skuttlebutt seems to have centered around an effort to embarrass or discredit a Syrian reporter. (1)

Given the abandonment this morning of an official OPEC quota (previously 30.0 mmbpd) , and another disappointing increase in weekly US DOE EIA inventory levels, crude oil prices are poised to test new lows.

As many financial speculators stepped aside or squared up to reduce risk ahead of the binomial OPEC meeting, price action should largely be determined by the mechanical effect of a shortening of speculators books until the threat of a Holiday liquidity drought kicks in.

What I find most notable in the week's information, is that the current acrimony between Riyadh and Moscow, obviously exacerbated by the Turkish decision to shoot down a Russian bomber, seems to explain more of the current Saudi mindset than straight economics. For example:

  • Why raise a stale quota now? The move is obviously symbolic as OPEC's own calculations show current production of 31.57 million barrels per day in September. 
     
  • Why would the Saudi's, who are extremely smart and calculated, support a potentially "negative" surprise emerging from the meeting in Vienna? Why would they permit false rumors of a production cut float via a Syrian reporter, only to whip around and zing the global audience with a poster-board "increase" in production?

It seems clear that while the unexpected strength in product demand (heavily weighted toward gasoline, not diesel) throughout 2015 is the fundamental basis for Saudi's comfort in choosing to continue a maximum-production price-war strategy, their resolve seems fueled equally by disdain for Russian activities in support of Assad, and hence Iran.

The superficial actions that have emerged from OPEC over the past 24 hours, only support the idea that economic rationalization may in fact be eclipsed by pure hatred, as the primary driver of realpolitik emanating from Riyadh, and by extension, OPEC, going forward.

Thus, I think it would be prudent for all oil analysts to keep tabs on the Ruble, and the level of Russian activity in Syria, as potentially leading indicators for where Saudi leads OPEC from here.

Yes, they will want everyone in OPEC to contribute to a cut. Yes, they are not interested in ceding unnecessary volumes to North American shale producers, Russian exporters in the Far East, and especially, to Iran upon partial lifting of sanctions as soon as this spring (my guess, no more than 300k/d initially). But the real juice in the fruit is emotional, and it has a certain "dasvidaniya" twinge to it. 

In predicting oil price probabilities going forward, please consider the following:

  • We know demand seems to be stronger than expected.
     
  • We know the forward curves continue to encourage (and pay for) high storage. (Indeed, except during extreme distortions - which we are not in currently, there's no such thing as excess production not finding a home and having to go into storage. Storage is a decision actively made, which is why most demand model calculations are just plain wrong).
     
  • We know that North American shale supply has not dropped off the cliff one would expect given the drop in capex and rig count ("North American Tail").
     
  • We are confident the long North American Tail can be explained by physical efficiency gains, drops in oil service prices (financial efficiency gains), and the real-world effect of lower-capital-cost-hurdles created by splitting economic decision making into two independent variables during development (i.e. the growth in inventory of drilled-but-not completed wells, and the emergence of stand-alone refrac opportunities).
     
  • We know that Brazil and Libya are disasters on the supply side, and that the surge in Iraqi production is precarious at best, and also not likely to repeat itself next year given the lack of capital willing to brave the threat of violence via IS and Syria.
     
  • We have anecdotal indications there was some contra seasonal de-stockpiling of Chinese inventories, perhaps currency driven.
     
  • We also know that every forecast for supply and demand is wrong to such a degree as to be unuseful for predictive analysis (see the WSJ article "OPEC’s Faith in Oil Demand Rise Rests on Shaky Ground"    http://on.wsj.com/1Q26xpE 

So what do you do to survive such an opaque market? How can one position to actually make money?

I think there's a fine opportunity to arbitrage long-term oil price volatility with a combination of distressed energy credit, short-term oil price volatility, and a portfolio of long-short energy related equities. For real asset players, ranging from E&P companies to private equity investors, the same investment can be created in the physical world using existing North American assets and capital structure arbitrage techniques involving CDS and debt.

No one knows where prices will go tomorrow. We do know what tomorrow's prices are today.  And thus, we know what probabilities are expected. It's far easier to express educated, rational opinions on those probabilities, than to get stuck having to guess on the timing and direction of oil prices. For all of you algorithmic types, my only suggestion today is to increase the weighting of the ruble in your signal. Good luck.

Matt Epsteinwww.aremet.com

(1) via Mike Rothman, Cornerstone Analytics

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