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Opec: kicking back against transparency?

As new technologies trump its modest initiatives, Opec may see value in telling the market less, and less predictably

Oil market watchers hoping to discern why Opec has cancelled its customary April meeting might take a clue from the poker expression of playing cards close to one's chest.

While potential strains over the Opec+ production agreement and uncertainty over future US decisions on Iran and Venezuela are credible explanations for the unusual decision to cancel the meeting, it is possible that Opec is discerning a value in becoming less predictable in its information sharing.

As recently as February this year, the cartel put out an 88-page special report trumpeting its various initiatives in support of market transparency and dialogues with other organisations. It did so on the basis that "only through constructive, meaningful and regular dialogue can the required awareness and understanding be reached with relevant parties on what conditions are necessary for attaining a stable oil market".

However, it is a potentially uncomfortable fact that its monthly oil market report and its joint oil data initiative (Jodi), while remaining useful as a back reference to previous months, have been rapidly overtaken by significant advances in crude oil cargo tracking utilising satellites, shore-based beacons and, increasing, AI. Oil traders can choose between one or more services offered by firms such as Kpler, OilX, Clipperdata, Vortexa, S&P Global Platts, IHS Markit and others, as well as their own in-house investments in tracking and big data.

In short, oil market transparency has moved out of the hands of Opec and other large producers and movers of crude and into the mainstream. Thus, one of the tools that Opec could use to try to manage the market-access to what it was doing in real-time compared to delayed and incomplete information for other participants-has gone.

Given that it has lost this advantage, might Opec benefit from a U-turn in its stated policy to promote transparency? To try to protect both its market share and revenues while discouraging marginal, high-cost production, might becoming less open and predictable, such as varying its usual meeting schedule, pay dividends?

Option theory suggests that it might. Unlike the national oil companies (NOCs) that comprise Opec membership, competitors and would-be competitors dependent upon private investment capital appraise exploration and production efforts on a risk-adjusted basis.

Using approximately 2mn bl/d of lifting capacity in a discretionary manner, Opec has adjusted output largely to absorb shocks, while protecting its market share. The benefits of stabilising oil markets through the operation of this discretionary buffer has been measured and they are huge. At a macro-economic level, it has been conjectured that Opec's stabilising role provides global benefits of approximately $20bn/yr in the short term in avoided costs, according to a 2017 Energy Journal paper by Pierru, Smith and Zamrik.

While this is a measure of the macro-economic benefits of fewer oil price shocks, it does not measure the value of reduced volatility specifically to non-Opec producers making investment decisions.

As shown in Fig1, price volatility in oil markets has varied considerably over time.

The rate of change in an option price with respect to volatility, Vega, shows the value of Opec actions that help reduce volatility reduction. As shown in Fig 2, for every percentage point reduction in volatility, for example, from 50pc to 49pc, the price of single option to hedge a barrel of oil, falls by approximately $0.23. [1]

On a volume of 2mn bl/d, the approximate volume of the Opec buffer, we calculate the annual hedging costs of a long straddle position, consisting of a long call and a long put as would be used to hedge price volatility, is approximately $2bn/yr as shown in Fig3. Although high-cost marginal producers will undertake their own hedging programs, they benefit significantly from any Opec efforts to reduce market volatility, significantly reducing costs or, dependent on their appetite to risk, the overall percentage volumes they feel they need to hedge.

Saudi Arabia and its fellow Opec members with swing capacity are in effect providing the benefits of risk management services to the global oil market using their discretionary production. And marginal high-cost producers gain as well. If marginal producers were undertaking their own hedging programs in a market where Opec was not showing commitment to price stability, it would have been at a significant cost. For non-hedged and partially-hedged producers, it would have increased their cost of capital given the risk tolerance of private investors.

For US shale producers with break-even costs of approximately $50/bl, according to consultancy Wood Mackenzie, imposing additional costs, either through more expensive hedging or higher capital costs for unhedged production in a more volatile market, could render their production un-economic, even while allowing for absolute prices to be higher on average.

Given the low-cost nature of Opec's output, it could certainly be argued that a price stabilisation strategy is counter-intuitive. In other extractive industries, managing price risk has been shown to be important for high-cost producers, not low-cost ones.

Perhaps Opec's cancelled meeting is a sign that it is looking to take a new course and, like a poker player, has decided that being more inscrutable is in its interests.

According to option theory, a useful way to achieve the holy grail of preserving market share and protecting revenues might just be to try to sow confusion and frighten marginal producers out of the market through behaving in a pro-cyclic manner and increasing volatility. And most of all, by saying less, rather than more.

Dr Lawrence Haar is senior lecturer in banking & finance at Oxford Brookes Business School

 [1] Using DerivaGem software the Vega, ∂Price/∂ Volatility =0.23. For every 1% change in volatility, the price of the option changes by approximately $0.23. We assume a risk-free rate of 3%, strike price = market price of $60 USD per barrel, expiry one year.

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