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Why oil is about to tank

Oil prices are on the march higher, again. It has been a volatile few weeks, with prices rallying fifty percent off their low from February, when they hit $26.05. After surging to $41.50, they then promptly fell to $35.24. Forty dollars beckons again this week.

The focus of the market has turned to the upcoming meeting among OPEC producers and Russia, this Sunday, in Doha, Qatar. Market participants are increasingly of the belief that the low prices have produced enough collective suffering to generate common cause among this increasingly disparate group.


Worker taking oil samples
Sergei Karpukhin | Reuters
Worker taking oil samples

It is difficult to believe that a deal will be struck. Since ruminations about this confab started, Russia, Iraq and Iran have all increased production, hitting output highs not seen since the end of the various eras associated with each of them: post-Soviet-era high, post-Saddam Hussein era high, and post-nuclear-sanctions high.

Iran, in particular, has staked out its position that it will not freeze output, until it reaches its pre-sanctions output level.

And there is more oil waiting in the wings.


Libya may finally see its government coalesce, allowing it to ramp up production and exports, once again. They, by the way, have declined to attend the meeting.

A statement last week by the Kuwaiti oil minister gave the meeting new street cred, when he proclaimed that there would be a deal, which was stated just days after the Saudi crown prince gave the meeting little chance of success, demanding that Iran freeze its output at current levels.

The Iranians keep raising production and exports, and they are aggressively fighting for market share, having just wrapped up a trade mission to India, and discounted its oil price to Asian buyers, in a bid to undercut Saudi Arabia. The discounting was unprecedented for Iran.

None of this sounds like a group that is ready to come together.





Oil prices have gotten support from other factors, such as strong gasoline demand and the falling dollar. The currency impact, in particular, has been pronounced over the past several weeks, from the yen's rally against the dollar. The falling value dollar causes dollar-denominated commodity prices to rise.

There were other fundamental factors, such as a significant supply pipeline outage in the Midwest and a fire at a large refinery in Houston last week.

Those represent transitory events, however, that will clear.

So, the Doha meeting represents considerable risk, especially as prices continue to rally into it.

Obviously, an accord that is viewed as prelude to further cooperation and a possible, future output cut, would spur the rally on. It would be quite remarkable.





On the other hand, if the meeting ends badly, look out below. And that is the more likely scenario. Recall how the last OPEC meeting ended, with the Saudi oil minister making a hasty retreat, with the meeting ending in acrimony and an abandonment of production quotas altogether.

The low prices have been a hardship, and some countries, like Venezuela, are suffering much more than others, and are in desperate need of a freeze deal that will, hopefully stabilize prices. But the big guys, like Saudi Arabia and Iran, are not desperate, yet. And, in the case of Iran, are standing on principal or, in the case of Saudi Arabia, playing for the long haul, where marginal, higher-cost producers get decimated.

It is almost impossible to see how the meeting concludes in a constructive manner. The successful jaw-boning of the oil market ahead of the meeting by leaders of these countries, will likely evaporate and prices tumble, once the reality of the position of the various producers crystalizes.




Commentary by John Kilduff, a partner at Again Capital, an investment-management firm that specializes in commodities. Follow him on Twitter @KilduffReport.

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