Singapore (May 12): Following a steep drop in crude oil prices stemming from the Covid-19 demand shock, crude oil futures markets looked up slightly this morning as Saudi Arabia is expected to announce further production cuts this June.
A Saudi official announced on Monday that the Kingdom intends to cut production by a further 1 million barrels in addition to agreed cuts with Organisation of the Petroleum Exporting Countries (OPEC). While this commitment will not completely rebalance present crude oversupply, other petrostates may follow suit - Kuwait and the UAE have already committed to decrease production by 180,000 barrels per day. This follows an earlier agreement between Russia and OPEC to cut oil production in April 2020 following a damaging price war.
“This brings the total production cut that will be carried out by the Kingdom, to around 4.8 million barrels per day, from the April production level,” said the official. “The Kingdom’s production for June, after both its targeted and voluntary cuts, will be 7.492 million barrels per day.” Saudi Arabia also encouraged other petro-states to comply with agreed production cuts as well as implement voluntary cuts to alleviate storage shortages and stabilise global oil markets.
Such gains are, however, expected to be transitory - while production cuts could somewhat stem oversupply and storage difficulties in 1H20, demand must recover for any resulting price gains to be sustained. With the IMF predicting that the global economy could contract by 3% this year and the US economy in particular shrinking 4.8% in 1Q20, such a demand rally is unlikely to be forthcoming amid the worst recession since the great depression. At the moment, a record 160 million barrels of crude sits idly in tankers around the world.
Despite countries beginning to gradually lift lockdown measures, fears of a second Covid-19 wave in Asia.
Markets in Europe and China took a bearish turn following the emergence of a new cluster in a South Korean nightclub and the reimposition of lockdown measures in the Chinese city of Shulan while US stocks settled mixed. A delay in the lifting of lockdown measures could further depress oil demand stemming from travel restrictions, exerting further downward pressure on crude prices.
Long-term structural changes to the structure of oil markets have also presented long-run dampeners on oil prices. The shale revolution in the US has led to the weakening of the previously hegemonic OPEC’s price-setting power within the “New Oil Order” while also significantly increasing the global supply of crude oil in the world market.
Still, such downward price pressures could put pressure on many shale firms, somewhat weakening shale oil’s ability to suppress oil prices going forward.
“The price war among the giant producers had deepened the contango structure of time-spreads in major oil futures markets, which traders and investors construed as the oil markets would be oversupplied going forth,” says Phillip Futures’ Avtar Sandu, “The oil market has all the ingredients of a Big Bear with higher production from Saudi Arabia and Russia, weaker demand from China and world inventories above its 5-year average.”
On the bright side, however, oil prices may be signalling that crude markets may be close to switching from surplus to shortage. The contango -- where the spot or cash price is lower than the futures price -- in the structure of the oil futures forward curve is narrowing faster than anticipated and Sandu anticipates that this may even change into backwardation by the end of May, encouraging oil storage to be delivered later in the year.
Sandu also anticipates central bank action and government intervention to prop up oil prices amid present price volatility, as the correction after a large sell-off would create selling opportunities for bears targeting below US$10 per barrel. The economic fallout of an oil price crash of this scale could also see central bankers cut interest rates to stimulate flagging economies.
Ultimately, the fate of crude oil futures depends on how quickly the global economy emerges from the lockdown and whether the lockdown lingers into 2021. At present, the OPEC+ deal finalised in May envisages initial cuts of 9.7 million barrels per day over the next two months, which is expected to taper off across the next two years into 1Q22 on top of further reductions in non-OPEC oil producers.
The speed of a rebound in consumer demand is also another factor in determining if the oil market can find balance once again.
