The following originally appeared on the Direxion Xchange blog.
OPEC announced that it would cut oil production by 1.2 million barrels per day to 32.5 million. This is the cartel’s first cut in eight years and will take place by January. The agreement exempted Nigeria and Libya, but included Iraq, and did allow Iran to raise its output as it recovers from US sanctions. In addition to OPEC, Russia also agreed to cut output.
Over the past two years, OPEC countries’ profits have dropped due to higher supply and lower demand. Wealthier members like Saudi Arabia have been able weather the storm. But the less wealthy, like Venezuela and Nigeria have struggled. OPEC has kept production levels stable because Saudi Arabia and Iran wanted to keep market share. But prices continued to drop – until last week’s cut.
The impact was almost instantaneous, as WTI crude oil blasted up 8.6%, nearly breaking $50, and energy stocks skyrocketed. Oil and energy-related stocks rallied.
The market was somewhat prepared, as the general consensus among traders was 50/50 as to whether the OPEC members would come to an agreement on the supply cuts.
Energy stocks, especially those of oil & gas exploration & production companies reacted sharply.
Can OPEC countries trust each other?
The big question is whether individual OPEC countries can trust each other. As any undergraduate economics student knows, the incentive to cheat for a cartel member is commensurate with the rise in price. The strength of the deal will depend on the commitment of all its members. So even though the back and forth headlines regarding OPEC policy that we’ve experienced since 2014 may seem to have come to an end, the truth is they probably haven’t.
As the weeks and months unfold, and the President-elect and the GOP has to commit to articulating and passing real policy, traders will have to find ways to find opportunity in the uncertainty. Now more than ever, direction matters.
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