Saudi Arabia, Iran and Russia: Trading UCO and SCO

April 04, 2016, 10:18 am ET, BY Thomas H. Kee Jr- Editor, Stock Traders Daily| Editor: Thomas H. Kee Jr. (Follow on LinkedIn)

My wife and I are currently being entertained by the latest season of House of Cards, the Netflix, Inc. (NFLX) exclusive series, and some people might argue that our interest in this political drama is well timed given the presidential race that is underway, the turmoil that is Donald Trump, and the questions that surround Hillary Clinton.

However, equally as political but less obvious to the naked eye, is what is going on in OPEC, and because we trade ProShares Ultra Bloomberg Crude Oil (UCO) and ProShares UltraShort Bloomberg Crude Oil (SCO) as that relates to WTI, and because the words from Opec largely influence those prices, the politics surrounding oil is much more immediately entertaining to me.

I'm specifically talking about Saudi Arabia and Iran.

Of course, there's more going on in the oil space than just what we're seeing from these two countries, but the price of oil has recently been influenced by the attention paid to what Saudi Arabia has said about their intentions to participate in a production freeze when Opec meets with Russian on April 17.  Their words suggested that they would not participate in a production freeze unless Iran did too.

Looking back a few weeks ago, Iran said that it would not participate in a production freeze based on January levels because sanctions were imposed on it back then and those sanctions have been lifted.  Most people would agree, and interestingly Saudi Arabia did as well, that imposing production limits on Iran based on levels that were reduced by sanctions was inappropriate, but that's not the entire story.

Prior to the imposition of those sanctions Iran was pumping about two million barrels per day, and initially Iran said that it wanted to get back to those pre-sanction production levels before considering any production caps, and it is that to which Saudi Arabia nodded its head. 

However, shortly after that Iran pushed the envelope and said that it did not want to consider any production Until it reached production capacity of four million barrels per day, double what was being produced before the sanctions were imposed, and until last week we did not hear any material complaints from the oil space, but that all changed when Saudi Arabia spoke.

When we dig between the lines things start to become clearer.

First of all, Saudi Arabia has openly acknowledged the right of Iran to produce oil and Saudi Arabia did not seem to have a problem with the two million barrels per day production, but doubling production is something that Saudi Arabia has a major issue with, but Iran was also okay with two million barrels per day initially before upping their number to four.

In many ways, what where seen in the oil space from OPEC is political.  Iran is starting to ramp up production again, they have been severely pressured for a while, and they want to be heard.  This is one of the best ways to do that, by pushing the envelope, and although they are unlikely to get the four million barrels per day that they want they will almost surely get two million barrels per day and some other acknowledgement from OPEC that might give them leverage when negotiating in the future.

Although Saudi Arabia has said that they will not agree to a production cap unless Iran participates, it is unlikely that they would even agree to a meeting unless they planned on reaching some sort of an accord that included Russia and Iran, so unless the meeting gets canceled we are expecting a deal.

Politics could also have another unique way of influencing Saudi Arabia to be vocal last week.  Oil prices had increased to levels that would allow some oil producers who had successfully reduce their costs to reengage, but oil only blipped up to those levels and they were not sustained.  In many ways, Saudi Arabia has wanted oil prices to fall, they want to see bankruptcies in addition to capex spending cuts, and they know they're on the verge of getting those.  The words from Saudi Arabia last week might also have been influenced by their desire to keep U.S. producers at bay.

When the dust settles, after the Meeting on 4.17.16, we expect Iran to be capped at just over 2 million barrels per day, we expect January Production Cap agreements by Russia, Saudi Arabia, and the rest of OPEC and participating nations, and we are expecting the price of oil to increase beyond recent highs.

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