OPEC, Fed minutes and Russel Crowe

The major news of the day was the inconclusive end of the OPEC + meeting and with no announcement on when the talks would restart again. The outcome which the markets were looking for was a planned and gradual increase in output by the OPEC plus countries. The delay in an agreement would mean that oil prices might continue to climb, supply is stuck whereas the demand rises with economic reopening. We had previously noted that the market is already priming up for high prices, in an interview last week Dallas Fed President Robert Kaplan specifically was asked his views on 100$/bbl oil and the reaction of US shale production to the same. Currently brent crude is trading around 77.4 $/bbl which is its highest since December 2018. Although it has not shown a violent upswing post the meeting abandonment, it would be prudent for asset owners in the oil importing nations to be watchful. Indian bonds especially would be fidgety going forward, higher oil directly feeds into inflation.

Now readers would note that the current stalemate in the OPEC+ meeting is an interesting phenomenon and can result in multiple scenarios going forward. As a forum OPEC is a meeting point for all the oil producers with an agenda to control the world output ultimately trying to control the prices. But the individual members come from divergent economic statuses. For few the low output and hence the low income is an acceptable bitter pill for future riches but for a few they need the money now to survive. This gives some the incentive to break the rank and increase the output on their own.

The intellectual framework for such kind of decision making is given by the Game theory. Though we are no expert in it and being a Russel Crowe fan remains our only claim to understanding the same, but we will still try our hand. A particular version of the 2-player game called Prisoner’s Dilemma gets played here. The two (hypothetical) countries in the question have two choices, follow the rules or violate. If both follow the production cut, the price remains high and both profit. If both violate, the price drops and both get hurt. The situation is different if one abides and one breaks the rule.

The game theory insight is that the countries will act as per their individual interest independent of others. They would see that violating the agreement gives a better result in both the scenarios (other one violating or following) hence it would be the preferred strategy. Hence the common wisdom can predict that there will be some break in the ranks moments before prices go too high. Who will break the rank and at what price point remains to be seen? We are sure that OPEC members are fully aware of this insight themselves hence they would not like to unnecessarily stretch any stalemate.

In other important news RBI announced the 20k Cr INR purchase of government securities under the GSAP 2.0 to be held on July 8. The current 10-year benchmark bond is trading at 6.08. The Dollar index is at 92.14 down a percent from pre NFP levels. The US 10-year and 30-year treasuries deal at 1.44 and 2.06 respectively. The release of FOMC minutes of last meeting is due tomorrow and as always markets will scour it for any hawkish hints. In UK it was announced that all covid related legal restrictions will come to an end this month. May be the English performance in Euro 2020 and Emma Raducona’s triumph in Wimbledon has added to the optimism.