LONDON Ministers from OPEC and non-OPEC oil-exporting countries agreed on Thursday to extend existing production cuts for a further nine months to the end of March 2018.
Front-month Brent futures prices reacted by closing down $2.50 per barrel or more than 4 percent, reversing around half of their gain the run up to the meeting (tmsnrt.rs/2qVNoyz).
The price decline was fairly predictable once OPEC decided to roll over existing production cuts rather than deepen them ("OPEC nears decision time: roll over or deepen cuts?" Reuters, May 19).
The market reaction was consistent with research showing prices tend to fall when OPEC leaves output unchanged ("The behaviour of crude oil spot and futures prices around OPEC and SPR announcements", Demirer and Kutan, 2010).
In this instance, the fall in prices reflects repositioning among market makers and short-term tactical traders rather than a re-evaluation of supply and demand fundamentals.
Many crude traders closed out short positions and bid up prices in advance of the meeting in case ministers surprised with a deeper cut ("Hedge funds shuffle positions as OPEC decision nears", Reuters, May 23).
OPEC and non-OPEC ministers signalled repeatedly that a rollover was the most likely outcome of the meeting but there was always the possibility, however small, of a deeper cut.
Most market makers and tactical traders will therefore have wanted to hold flat or a small long position during the meeting in case a surprise cut sent prices rising sharply.
Once the threat of a cut was removed and the rollover was confirmed many of those long positions became unnecessary and were liquidated.
The simultaneous attempt to liquidate so many long positions at the same time and create fresh short positions resulted in a classic crowded trade ("Predatory trading and crowded exits", Clunie, 2010).
In any event, the price decline was not especially large, equivalent to a daily move of just over 2 standard deviations and well within the normal range of daily fluctuations (tmsnrt.rs/2qqwPXX).
OPEC and non-OPEC ministers may be mildly disappointed with the response to their announcement but they are unlikely to be seriously concerned.
(Editing by David Evans)