The phrase ‘buy the rumor, sell the news’ is overused on Wall Street for a reason. Prior to significant events, prices tend to rise on rumors and then drop sharply following a highly anticipated event. Looking at WTI, the last OPEC meeting (May 25, 2017) is a great example of this pattern.

Rumors of deeper OPEC cuts ultimately unfounded

Prior to the event, crude oil speculators drove WTI prices above $50. At the time, some speculated that OPEC may extend and deepen supply cuts simultaneously. While OPEC met Wall Street’s consensus expectations by extending supply cuts to the first quarter of 2018, prices fell nonetheless. On the day of the announcement, prices dropped by 4%. Over the next several weeks, WTI proceeded to weaken until ultimately bottoming around $42 per barrel. The almost 20% drop in crude oil prices from its earlier peak occurred in spite of the fact that (1) net speculator positions in futures & options were not at extremes based on CFTC data, and (2) underlying demand growth was running significantly ahead of supply at the time. In other words, both sentiment and fundamental drivers of crude oil were supportive of higher prices. A historical overview of WTI prices is shown below for reference:

The market front runs the OPEC announcement

Source: NYMEX futures / TradingView.com

The stakes are much higher today

Given price action in crude the last time, the stakes today are much higher for three reasons.

Firstly, speculation is rife that another supply cut is imminent following King Salman’s landmark visit to Russia earlier this year. As the first Saudi monarch to visit Russia, the event was significant as the two countries are supporting opposite sides in the ongoing Syrian conflict. Russia has also been a traditional ally of Iran, Saudi Arabia’s arch nemesis in the Middle East. Despite the historical differences, the two countries appear to be cooperating as higher crude oil prices are in everyone’s interest. The event was marked by significant pomp and ceremony, and Saudi Foreign Minister Adel al-Jubeir claimed that “relations between Russia and Saudi Arabia have reached a historical moment.” Following the event, expectations are high that another OPEC/Russia supply cut extension is in store.

The second risk factor is that long crude oil has become a consensus favorite ahead of the OPEC announcement on November 30. Looking at recent data from the CFTC’s Commitments of Traders report, there are 621,717 futures and options contracts net long in US markets today. This is 55% higher than the COT report immediately preceding the last OPEC announcement, when net long positions totaled 400,402 futures and options contracts. A visual overview of net speculator positioning vs. 1-year z-scores is shown below for reference:

As long crude gets more crowded, the risk of a stampede for the exits rises

Source: CFTC, MarketsNow

The last risk factor is that the fundamental dynamics of the crude oil market look set to change in 2018. In the second and third quarter of this year, US crude supply growth has been running above 3%. Looking at the International Energy Agency’s forecasts, US supply is expected to accelerate beyond 5% in 2018 and peak at 7% in the third quarter of 2018. As supply from the US is set to flood crude oil markets once again, a bear market in crude may only be one quarter away. A visual overview of the IEA’s forecasts is shown below:

Crude bear market ahoy?

Source: IEA Oil Market Report, US EIA OPEC supply estimates

Needless to say a crude bear market is far from certain, and the IEA’s forecasts are subject to substantial risk. Potential developments such as Trump choosing re-enact sanctions on Iran (which may remove up to 1m barrels per day of supply), an escalation of the current tensions between Saudi Arabia and Iran, and more bottlenecks in the US may result in lower future supply.

In conclusion

All in all, the stakes for the upcoming OPEC event are very high and crude oil speculators should trade accordingly. Relative to the last event, markets have very high expectations for OPEC's upcoming announcement despite a resurgence of US shale.