»5 Minute Wrap Up by Equitymaster

On This Day - 4 DECEMBER 2018
Forget About RBI's MPC Meeting. Focus on This More Important Meeting Instead

Sarvajeet Bodas, Research analyst, The 5 Minute Wrapup

The Reserve Bank of India (RBI) will meet this week. Most likely, the RBI will maintain status-quo on interest rates due to the slowdown in economic growth and low inflation.

But there's another meeting which, I believe, is more important for the economy and the market.

The OPEC meeting.

Four years back, in November 2014, the Organisation of Petroleum Exporting Countries (OPEC) met in Vienna. After that meeting, the price of crude oil fell more than 7% in just 24 hours.

That meeting was a trigger point for a downward trajectory of crude oil prices.

Why did that happen?

Well, Saudi Arabia, the world's biggest oil producer, declined calls from the smaller members of OPEC for production cuts which could have stopped the slide in oil prices.

OPEC decided to keep pumping instead of surrendering further market share to shale oil producers in North America.

The result?

Oil prices, which were averaging US$ 100 per barrel at that time, crashed and closed the year at nearly US$ 55 per barrel.

Since then, achieving a balance in the oil markets has proved to be a challenge for OPEC.

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2018 has been a prime example of that.

In the first half of this year, these countries were cutting back production to get rid of the oversupply situation in the market.

Thus, oil prices rallied by around 28% in the first ten months and touched record high of US$ 85 in October 2018.

However, the risk of an oversupply emerged again after the OPEC and its allies, including Russia, agreed to raise production. They were partly responding to an expected loss of oil supply from Iran due to US sanctions on that country.

But when Donald Trump is in the picture, you must expect the unexpected.

So, when the sanctions went into effect in early November, the Trump administration granted waivers to Iran's biggest customers including China and India.

Not to mention, US oil production has surged in the meantime.

In fact, for the first time since 1973, the US is now the world's largest producer of crude oil.

With this, oil prices have been on a falling spree and has declined more than 30% in the last two months. Prices are at their lowest levels in more than a year.

But this is the supply side of the equation.

What about the demand side?

Well here too, things aren't looking bright for oil producing countries.

Global oil demand is showing signs of cooling. And an escalation of the US-China trade war threatens to make things worse.

That's why this week's OPEC meeting is crucial. It will determine the next move in oil prices.

This meeting is crucial for India as well.

India's energy needs are mainly met through imports, and OPEC accounts for more than 80% of the country's total crude oil imports.

The price of crude oil is more important than any other metric because inflation, the rupee-dollar exchange rate, the trade deficit, the fiscal deficit, and more...all depend on it.

I believe, the sweet spot for oil prices is around US$ 60-65 range. At this price, it's a win-win situation for both i.e. oil consuming as well as oil producing countries.

The stock we recommended in Smart Money Secrets five months ago would certainly do well if oil price stabilise in this range.

It's just a matter of buying this stock at the right price. And at the current price, this stock is a buy.

So, what will happen in tomorrow's OPEC meeting?

Will they agree to cut production?

This is a catch-22 situation.

If OPEC cuts output to support prices, it will only revive its biggest enemy - the US shale oil industry.

If they decide to maintain the production, as they did in late 2014, oil prices will get crushed.

Watch this space!

Chart of the Day

Talking about the OPEC meeting and its impact on crude oil prices, I found some interesting data.

I wanted to check the impact on crude oil prices immediately after OPEC meetings.

I considered November 2014 as the starting point for this exercise.

Guess what? After OPEC meetings, crude oil prices have seen volatile moves both ways.

Look at this chart...

Volatile Up and Down Moves Post-OPEC Meetings

In the last four years, crude oil prices have moved between -7% and 9% in a single day immediately after OPEC meetings.

So, I won't be surprised if we see a similar volatility after Thursday's meeting.

It is important to note that, in the short term, OPEC has significant influence on the price of crude oil. But in the long term, its ability to influence the price of oil is quite limited. This because individual countries within OPEC have different incentives than the group as a whole.

Sarvajeet Bodas
Sarvajeet Bodas
Research Analyst, Smart Money Secrets

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