Analys
An age of unprecedented oil volatility


We are living in a time of unprecedented volatility in oil. That is the consequence of a twin shock: both demand is collapsing and supply is rising. Oil prices are now more volatile than they were in the Great Financial Crisis (that started in 2008) or the oil price war of 2014-2016.

The sheer drop in prices over a short timespan has rarely been seen before. Neither in 2008 nor 2014 did we see such a sharp decline. If we were to annualise the price decline we have seen in the past two weeks, it will outpace the price declines of 2008 and 2014.

The protagonist seeks vengeance
As we discussed in Post OPEC meeting note -OPEC’s Greek Tragedy, the events of 5th and 6th March profoundly changed the oil markets. The Organization of the Petroleum Exporting Countries (OPEC) and its partner countries (collectively known as OPEC+) failed to reach an agreement on policy. We believe that OPEC is functionally dead as a result. Since 2017, OPEC has been reliant on Russia to endorse OPEC’s policy and even though Russia has habitually failed to follow through with implementation of quotas in full, the unity has been symbolically important as Saudi Arabia has been willing to cut more than its fair share to compensate. With Russia’s betrayal to this alliance, Saudi Arabia is now slashing prices and raising production. The chart below shows the Saudi official selling price of Arab light crude oil to Asia as a spread over the average cash Dubai price and Oman crude oil future price. Saudi Arabia is selling oil at close to a US$3/bbl discount to its peers. After Saudi Arabia refused to participate in the Joint Technical Committee originally scheduled for March 18th, the meeting was cancelled.
To be clear, Saudi Arabia now has its own agenda: to inflict maximum pain on Russia and it doesn’t seem to care which casualties it will take with it. Saudi Arabia intends to expand capacity to 13 million barrels per day from 12 million barrels per day currently. Saudi Arabia was producing 9.6 million barrels per day in February 2020. If Saudi Arabia produces at capacity, the world will be awash with oil.

Twin shocks drive extreme contango
This supply shock is coming at a time when demand is severely hampered by COVID19. This double-whammy has caused extreme contango in the oil markets. The day before the OPEC meetings, oil was in mild contango, with the difference between 1st and 36th contract only between US$2bbl and US$3bbl (WTI and Brent). On 19th March 2020, the contango has become extreme, with the difference between 1st and 36th contract between US$17/bbl and US$18/bbl (WTI and Brent). Only in the depths of the 2008 Great Financial Crisis had we seen contango this deep.

Where will this end?
The pain from the 2014-2016 oil price war is still raw in OPEC countries’ memories, yet it failed to deter Saudi Arabia from engaging in a fresh price war with Russia. We don’t think that the group will change course anytime soon. We don’t think the rest of OPEC can operate without Saudi Arabia. Saudi has been responsible for most of the group’s swing-production – i.e. building spare production capacity that can be used in times of demand surges or supply outages.
We doubt that the rest of the world will be able to adjust to this new reality quickly. Most global oil companies do not use the Saudi Aramco (state oil company in Saudi Arabia) model of keeping redundant capacity. Shuttering production for most oil companies is slow and costly to the point of putting the company’s finances under fatal strain.
There have been discussions, confirmed by US Energy Secretary Dan Brouillette of the possibility of a joint US-Saudi oil alliance. It was only one of many strategies discussed by policy makers in the US and we doubt that the US will partake in a cartel that it has been criticizing for decades. But desperate times may call for desperate measures. After all, the OPEC cartel was designed on the Texan oil practices from the 1930s to 1970s2.
More likely, we believe that the US will allow market economics to trim back on production. Our working assumption is that the breakeven price for oil production in the US is US$50/bbl. With WTI prices at US$25/bbl at the time of writing, US oil producers are going to suffer and we expect bankruptcies to soar. In the 2014-2016 oil price war, rigs in operation in the US fell by two-thirds. The US is dominated by shale oil production, which does not have the same lengthy lead times for switching on and off production as traditional oil production. But the decline in rigs came at a time when technological improvements to production techniques were rising fast. So, the ultimate decline in production was not that steep. This time, rigs in operation which have already been declining for a year could be matched by commensurate declines in production. The US could in effect become the world’s new swing producer.

Analys
All eyes on OPEC V8 and their July quota decision on Saturday

Tariffs or no tariffs played ping pong with Brent crude yesterday. Brent crude traded to a joyous high of USD 66.13/b yesterday as a US court rejected Trump’s tariffs. Though that ruling was later overturned again with Brent closing down 1.2% on the day to USD 64.15/b.

US commercial oil inventories fell 0.7 mb last week versus a seasonal normal rise of 3-6 mb. US commercial crude and product stocks fell 0.7 mb last week which is fairly bullish since the seasonal normal is for a rise of 4.3 mb. US crude stocks fell 2.8 mb, Distillates fell 0.7 mb and Gasoline stocks fell 2.4 mb.
All eyes are now on OPEC V8 (Saudi Arabia, Iraq, Kuwait, UAE, Algeria, Russia, Oman, Kazakhstan) which will make a decision tomorrow on what to do with production for July. Overall they are in a process of placing 2.2 mb/d of cuts back into the market over a period stretching out to December 2026. Following an expected hike of 137 kb/d in April they surprised the market by lifting production targets by 411 kb/d for May and then an additional 411 kb/d again for June. It is widely expected that the group will decide to lift production targets by another 411 kb/d also for July. That is probably mostly priced in the market. As such it will probably not have all that much of a bearish bearish price impact on Monday if they do.
It is still a bit unclear what is going on and why they are lifting production so rapidly rather than at a very gradual pace towards the end of 2026. One argument is that the oil is needed in the market as Middle East demand rises sharply in summertime. Another is that the group is partially listening to Donald Trump which has called for more oil and a lower price. The last is that Saudi Arabia is angry with Kazakhstan which has produced 300 kb/d more than its quota with no indications that they will adhere to their quota.
So far we have heard no explicit signal from the group that they have abandoned the plan of measured increases with monthly assessments so that the 2.2 mb/d is fully back in the market by the end of 2026. If the V8 group continues to lift quotas by 411 kb/d every month they will have revived the production by the full 2.2 mb/d already in September this year. There are clearly some expectations in the market that this is indeed what they actually will do. But this is far from given. Thus any verbal wrapping around the decision for July quotas on Saturday will be very important and can have a significant impact on the oil price. So far they have been tightlipped beyond what they will do beyond the month in question and have said nothing about abandoning the ”gradually towards the end of 2026” plan. It is thus a good chance that they will ease back on the hikes come August, maybe do no changes for a couple of months or even cut the quotas back a little if needed.
Significant OPEC+ spare capacity will be placed back into the market over the coming 1-2 years. What we do know though is that OPEC+ as a whole as well as the V8 subgroup specifically have significant spare capacity at hand which will be placed back into the market over the coming year or two or three. Probably an increase of around 3.0 – 3.5 mb/d. There is only two ways to get it back into the market. The oil price must be sufficiently low so that 1) Demand growth is stronger and 2) US shale oil backs off. In combo allowing the spare capacity back into the market.
Low global inventories stands ready to soak up 200-300 mb of oil. What will cushion the downside for the oil price for a while over the coming year is that current, global oil inventories are low and stand ready to soak up surplus production to the tune of 200-300 mb.
Analys
Brent steady at $65 ahead of OPEC+ and Iran outcomes

Following the rebound on Wednesday last week – when Brent reached an intra-week high of USD 66.6 per barrel – crude oil prices have since trended lower. Since opening at USD 65.4 per barrel on Monday this week, prices have softened slightly and are currently trading around USD 64.7 per barrel.

This morning, oil prices are trading sideways to slightly positive, supported by signs of easing trade tensions between the U.S. and the EU. European equities climbed while long-term government bond yields declined after President Trump announced a pause in new tariffs yesterday, encouraging hopes of a transatlantic trade agreement.
The optimisms were further supported by reports indicating that the EU has agreed to fast-track trade negotiations with the U.S.
More significantly, crude prices appear to be consolidating around the USD 65 level as markets await the upcoming OPEC+ meeting. We expect the group to finalize its July output plans – driven by the eight key producers known as the “Voluntary Eight” – on May 31st, one day ahead of the original schedule.
We assign a high probability to another sizeable output increase of 411,000 barrels per day. However, this potential hike seems largely priced in already. While a minor price dip may occur on opening next week (Monday morning), we expect market reactions to remain relatively muted.
Meanwhile, the U.S. president expressed optimism following the latest round of nuclear talks with Iran in Rome, describing them as “very good.” Although such statements should be taken with caution, a positive outcome now appears more plausible. A successful agreement could eventually lead to the return of more Iranian barrels to the global market.
Analys
A shift to surplus will likely drive Brent towards the 60-line and the high 50ies

Brent sinks lower as OPEC+ looks likely to lift production in July by another 400 kb/d. Brent crude declined 0.7% yesterday to USD 64.44/b and traded in a range of USD 63.54 – 65.03/b. This morning Brent is down another 0.7% to USD 64/b along with expectations that OPEC+ will lift its production quota by another 411 kb/d in July.

Kazakhstan would be in breach even if the whole 2.2 mb/d of voluntary cuts are unwounded. The eight countries behind the 2.2 mb/d of voluntary cuts, the V8, have lifted their production quotas by close to 950 kb/d from April to June with unwinding starting in April. Over the coming week towards the end of May, the group will discuss what to do with quotas in July. Market expectations as well as indications from within the group is for another 411 kb/d hike also in July. Higher oil demand during summer both in the Middle East and globally is one reason for the hikes. Most of the additional production will not leave the Middle East but be consumed locally this summer. But Kazakhstan is also a major problem. The country produced 1.77 mb/d in April and 300 kb/d above its quota level. To maintain cohesion and credibility the group needs internal cooperation and harmony. Kazakhstan seems to have no plans to reduce production down to its quota. The alternative solution to reestablish internal harmony is to lift quotas up to where production is. The problem is that Kazakhstan only accounts for less than 5% of the overall production of V8. Thus even after unwinding all of the 2.2 mb/d, the quota of Kazakhstan would not rise much more than 100 kb/d. Far from the country’s overproduction of 300 kb/d in April.
A shift to surplus will likely drive Brent towards the 60-line and high 50ies. Losing front-end backwardation implies Brent crude down to the 60-line and high 50ies. Currently the Brent crude curve holds a front-end backwardation premium of USD 1.5/b versus the November price currently at USD 62.6/b. A result of an oil market which is still tight here and now. But if OPEC+ lifts production to a level where the market starts to run a surplus, then the front-end contract will flip from a USD 1.5/b premium vs. 4 months out to instead a comparable USD 1.5/b discount to 4 months out. That would bring the front-end contract down towards the 60-line and the high 50ies. This because a full out contango market usually also will drive the deferred contracts a bit lower as well. But this may not be all doom and gloom. A softer USD and a lower oil price is a powerful combo for global consumption. Global oil stocks are also low. This will help to cushion the downside.
Brent crude forward curve. Surplus and full contango would eradicate the front-end backwardation and drive Brent crude down towards the 60-line and high 50ies.

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