I was told by a friend on the street (thanks for the nudge JL) just now to interrupt my 3-4 consecutive day blogs on Macro Views and to write one on Oil and OPEC. So here goes...
As most of you know, and certainly a lot of people in Alberta and Saskatchewan, OPEC is meeting in Vienna tomorrow (Nov 30th). This is rather significant for two reasons: 1) There has been a wild game of chicken leading up to the meeting and 2) At the current price of WTI ($~45), the outcome is highly likely to be binary...that is to say, should they not agree on production cuts for the Saudis and at least a production freeze for Iraq and Iran, the price of oil will likely drop back below $40 and into the $30's. On the upside, should they all hold hands, sing Kumbaya and agree to solid production cuts, then the price of oil could easily gravitate back to the mid-50's. Binary - $10 down, $10 up.
So far, the Saudis have come out Sunday night and said that a production cut is not necessary for oil to hit equilibrium at higher levels in mind-2017. They certainly set the stage. Then Iran and Iraq say they won't cut and they should be allowed to restore production to levels from long ago before various sanctions were put in place against them.
In Algiers in September, OPEC producers agreed to cut about 1.2mm barrels of oil per day. Both Iran and Iraq are arguing for an increase and a freeze, respectively, in their production levels. This is something that the Saudis can't seem to agree upon with Iran and Iraq. I wonder if religion has anything to do with it? Sunni vs Shia.
And the game of chicken ensues as:
And on the periphery, there are lesser OPEC Members who will just go along for the ride as well as try to mend fences, but there are also large state-sponsored, non-OPEC producers like Russia in the picture. Russia claimed this morning that they won't even attend the Vienna meeting tomorrow. Maybe Trump can convince Putin to attend? (funny, but he would have a better chance than Hillary).
How the hell OPEC maintains its current structure is anyone's guess. With the advent of North American fracking at much lower costs than traditional vertical drilling, our producers here will push a lot more supply into the market if there is a production freeze/cut. We don't see oil getting much above $60 for quite some time due to shut-in, unprofitable wells coming back on-line.
With regards to positioning, we have most of our energy exposure through high yield bonds rather than stocks. A few reasons for this: 1) We actually have access to high yield bonds with on-the-screws pricing because of the Institutional funds we manage for BNS, 2) High Yield bonds are historically less than half as volatile as their underlying stocks and 3) Most of these oil and gas producers have continued to sell equity to raise capital, which is good for their underlying high yield bonds (puts capital underneath the bonds).
We will know in less than twenty-four hours how the game of chicken played out.