Yesterday we received the news that OPEC failed to reach an agreement after several days of meetings. I was surprised to see oil prices rally in the immediate wake of the talks’ failure, and quite frankly not all that surprised to see some significant selling today. There are some basic trading mechanics that came into play. We can use the chart below for reference:

2 Day Tick Chart of Front Month WTI Crude Oil Futures

(Click on image to enlarge)

Source: Bloomberg

I believe that the initial rise was the opposite of buy the rumor / sell the news.  When stocks or commodities have sharp moves ahead of a news release or widely anticipated event, it is quite normal for them to reverse somewhat even if the news is what traders had hoped for. The rationale is that markets are discounting mechanisms, so if the news is fully discounted into the current price of a tradeable instrument, there is no reason to continue the prior move and profit-taking ensues. 

Crude had been rising steadily into the OPEC meeting, which left it primed for selling on the news. But the news never arrived. Bullish traders may have seen that as a signal to continue their buying ahead of a future agreement, or short sellers anticipating a dip after the meeting were forced to cover. Either way, it is understandable why the first move was higher even in the absence of anything overtly positive.

Later in the morning (US time), it appears that there was a change in sentiment. Perhaps it was the realization that cheating tends to occur in the absence of output agreements among the OPEC members. A lack of agreement means a lack of firm production limits, and it is tempting for producers to exceed those limits when prices are high. Also, we have been approaching a long-term resistance level for crude, as evidenced in the chart below:

5 Year Daily Chart of Rolling Front Month WTI Crude Oil Futures

(Click on image to enlarge)

Source: Bloomberg

It is believed by many oil experts that OPEC has little interest in seeing prices rise much above the $75-$80 level. At those prices, North American shale oil production becomes profitable, leading to a large source of non-OPEC supply potentially coming into the market. Countries that have a low cost of production, like Saudi Arabia, can make significant profit at current prices yet keep a source of high-cost crude on the sidelines. 

Finally, might some profit-taking be expected after such a sharp run-up, no matter what the commodity in question? The global economic picture is improving dramatically, but it is still not back to levels that we saw pre-pandemic. If it were purely about supply and demand, we could argue quite strenuously that the price movement had gotten ahead of demand. But we have also seen huge monetary stimulus on an unprecedented global scale. We have seen that flow of money create inflation in a wide range of global assets. It should not be surprising to see rising prices in commodities that is driven as much by money flows as by traditional demand.

Looking ahead, it would not surprise me to see crude oil prices meander with some slight profit-taking if OPEC is unable to return to the table and put together a lasting agreement. It seems to me that the cartel’s history of output increases when a deal is not in effect and the desire by some members to keep shale producers on the sidelines would put some pressure on oil unless conditions change.