Market Overview

16 July 2020

OPEC+ Convinced the Market that Reduced Cuts Are Justified

European stocks are slightly dropping after yesterday's take-off due to uncertainty on whether the recovery fund will eventually be approved with some possible intermediary news this Friday, when EU leaders will gather in person to seek a deal. Meanwhile, the epidemic situation in North and South America continues to threaten the global investment climate. The U.S. has recorded an all-time daily peak of 71,500 new positive viral tests on July 15, although the daily COVID-related death numbers in July remains half of what it was in spring, before the economy began to re-open. However, the Organisation of Petroleum Exporting Countries (OPEC) and its allies seem to feel hugely more comfortable.

Most likely, major exporting countries believe in a partial further recovery of oil demand in the coming months. At least, they'd like to preach their faith in such a scenario to the desert wind blowing among the commodity market investors. Otherwise, why did they agree to taper their record oil output curbs, and to lessen the supply restrictions already from August? Just a month ago the ministerial group of OPEC+ extended the previous quotas with output cuts of 9.7 million barrels per day (bpd) since May, which meant approximately ten % of global supply. At Wednesday's meeting, they assumed that the reduction was too heavy and changed it to only 7.7 million bpd until December 2020.

Despite the official OPEC+ accord, Prince Abdulaziz bin Salman, who represented Saudi Arabia at the meeting, said total production cuts in August and September would actually end up amounting to about 8.1-8.3 million bpd. So, cuts are expected to exceed the level proposed by OPEC+ for at least two months more because several countries which failed to meet their personal quotas according to the agreement should compensate overproduction by making extra August-September cuts. The point is that since May, the deal has been fulfilled only by 87% due to insufficient commitment of their obligations by Iraq, Kazakhstan, Nigeria, Angola and some other countries. At the request of Riyadh countries that did not reduce their production enough should compensate their lag later. To fully offset shortcomings of all the delinquent nations 842,000 barrels a day of extra reductions in August and September is required, delegates said. Another matter is whether this would actually happen in practice if global demand increases so much that it may cause increased interest to produce more export volumes.

On the other hand, the volume of increased production of "black gold" in the next stage of the OPEC+ deal will most likely be consumed in the domestic market of the alliance countries. This was declared by the head of the Russian Energy Ministry Alexander Novak. Thus, he believes that the easing of output restrictions to 7.7 million barrels per day are justified. The tapering of production cuts is “fully in line with the current market trends,” Mr Novak said.

Saudi Arabia’s own exports won’t change next month despite the output increase, as its domestic demand rises, Prince Abdulaziz echoed. However, the Saudi Minister sees encouraging signs of improvement in the global demand situation too, both on the physical market and on the futures oil market, as economies around the world are starting to open up. “As we move to the next phase of the agreement, the extra supply resulting from the scheduled easing of production cuts will be consumed as demand continues on its recovery path,” Prince Abdulaziz said at the start of an OPEC+ video conference. “Economies around the world are opening up, although this is a cautious and gradual process. The recovery signs are unmistakable,” he said. The group would only consider calling an emergency meeting to reverse the easing of its cuts if severe economic lockdowns return, he added.

And it seems that at least some individuals in the market believed in the Saudi thesis about the gradual recovery of global demand. This conclusion could be made since prices initially jumped almost to the area of $44 per barrel of Brent crude benchmarks just after the announcement of the OPEC+ decision. Later, prices rolled back, but they continue to hold above the $43.3 per barrel mark, and are seen to not be in a hurry to slide lower for now. 

“Things are getting back to normal on the oil market,” said Norbert Rücker, head of economics research at Julius Baer. “The petro-nations announced the partial lifting of their production restrictions as oil demand rebounds and signs of an easing supply glut emerge... The economic recovery puts demand above supply,” he added. So, markets may hold the view that if OPEC and allies raise production then exporters know something good about the future or at least they access the present moment situation better than the market. Therefore, if any unexpected and exaggerated news outbursts about the spread of the infection do not spoil the situation dramatically then the oil market may see another rise.

Oil prices are expected to remain boxed in as more supply from OPEC+ countries will likely be absorbed by recovering demand, said Tsutomu Kosuge, president of the commodity research firm Marketedge Co. “I expect Brent will stick to the tight range between $40.50-$46.50 for the next month or so,” he said, adding that rising tensions between China and the United States may weigh on market sentiment. “Nobody could really expect OPEC+ to keep the 9.7 million barrel-a-day curtailments into August,” Paola Rodriguez-Masiu, senior oil markets analyst at consultant Rystad A/S commented. “Boosting output by 2 million barrels a day is not little, but the demand recovery, even though a little slower than expected, justifies it.”


Disclaimer:

Analysis and opinions provided herein are intended solely for informational and educational purposes and don't represent a recommendation or investment advice by TeleTrade.


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