“Whatever it takes” – can Draghi’s magic words work in the oil market too?

“Whatever it takes”.

Those three little words have become the “go-to” phrase for anyone who wants to draw a line in the sand of financial markets.

They acquired their mystique when Mario Draghi, boss of the European Central Bank, used them successfully to demonstrate his determination to protect the euro in July 2012. Markets backed off, because they believed him.

Now saying “whatever it takes” is the market equivalent of Gandalf planting his staff in the ground and bellowing, “YOU SHALL NOT PASS!” to the Balrog in Lord of the Rings.

And now Russia and Saudi Arabia have unleashed the power of “whatever it takes” on the oil market.

Can they back it up with action? Or will markets call their bluff?

Oil producers of the world unite

Late last year, oil cartel Opec, along with Russia and some other non-Opec members, agreed to reduce oil production. The idea was to boost prices by hacking back supply.

None of the participants would have enjoyed doing that. There are a lot of risks involved. Firstly, can you trust your fellow cartel members? If you don’t produce oil, but customers still want it, there’s a big temptation for your erstwhile allies to go behind your back – particularly the ones who are under the most financial pressure.

Secondly, even if your partners don’t stab you in the back, there’s a lag between cutting production and prices going up (and no guarantee that your efforts will work). So you immediately see your revenues fall even further than they already have. That’s no fun either.

Finally, of course, the more you try to wield your power in the market, the more you run the risk of alienating consumers, who try to find alternative suppliers – either US shale producers, or even alternative forms of energy.

So far, the oil barons appear to have managed to stick to the plan – indeed, Saudi Arabia has been “over-complying” – cutting by more than expected. But the oil price has been distinctly wobbly of late, and it looks as though it could do with a bit more cajoling higher.

Yesterday, Saudi Arabia’s energy minister, Khalid al-Falih, announced that he expects the production cuts to be rolled over until at least March 2018, longer than had been expected. And that’s when he used Draghi’s magic words: “The producer coalition is determined to do whatever it takes to achieve our target of bringing stock levels back to the five-year average.”

Ultimately, reports the Wall Street Journal, the biggest Opec producers – Kuwait and Iraq, as well as Saudi Arabia, have a price target of around $60 a barrel in mind. They reckon that’s the “Goldilocks” price at which US shale producers will survive, but struggle to increase production hugely, while Opec governments will make enough money to boost spending at home. Moreover, Saudi Arabia wants $60 a barrel to that it can get on with listing the state-owned oil company, Aramco.

Markets liked the news. The price of Brent crude – the European oil price benchmark – rose to more than $52 a barrel, having hit a five-month low of less than $47 in March this year. Meanwhile, the US benchmark, West Texas Intermediate, rose to above $49.

However, it’s a tricky business. At the end of the day, Opec can influence the oil market but it can’t control it – and it certainly can’t set the price. And the weakening US dollar also helped the oil price – there was some disappointing manufacturing data and it sent the US currency lower, which tends to be good news for dollar-denominated assets.

Oil prices might just have found a healthy medium

So can Russia and Saudi Arabia pull this off? The fact that they have made this announcement together, does suggest that non-compliance is less likely to be a huge issue than you might expect.

Kazakhstan has already warned that “it could not join a prolonged reduction on the same terms”, reports Reuters. But overall, says one oil broker, “when the two biggest oil producers of the world reach a consensus on the extension of a supply cut, the market will listen”.

Meanwhile, there’s another reason to be fairly bullish on oil prices – the rest of the market is pretty gloomy. Speculators are making the most bearish bets on the oil market since records began (admittedly, that’s only in 2011, so a much shorter track period than it might seem).

When more people are bearish than bullish, you tend to get bigger reactions to bullish news (obviously the same goes for the other way around). It means there are more people caught on the wrong side of the trade, and more potential for them to have to run to the other side sharpish.

Perhaps more importantly, it increasingly feels as though Opec and Russia have decided that they cannot just sit back and hope that prices recover to a level that they are comfortable with. This joint decision demonstrates that they really are keen to do “whatever it takes”.

That doesn’t mean that the oil price will rocket higher. The cartel wouldn’t want that because it would rapidly encourage a reaction from US shale producers. Instead, Capital Economics reckon that the price of crude “will drift up slowly in the next few years as demand remains healthy.”

What’s the upshot for investors? The big recovery has already happened in the oil sector. We’re not looking at bargain basement prices for near-dead shares anymore. But if you are tempted to buy big oil majors for the dividend yields (which remain pretty tasty-looking) then I suspect that you’re safe to do so.

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