Prices pull back as market awaits OPEC+ and demand signals

SEB - Prognoser på råvaror - Commodity

The Brent crude oil August contract traded briefly above the $40/bl line yesterday but has now pulled back again as the market is awaiting a decision by OPEC+ whether to roll current cuts of 9.7 m bl/d beyond June. We think that there is a better than even chance for this happening but a final decision is probably not available before mid-June as the group struggles with how to whip cheaters into line. Current demand signals from the US are also weak but will most definitely strengthen again at some point in time in the coming months. Crude oil prices are pulling back awaiting OPEC+ and demand signals. Use the opportunity to buy 2021.

Bjarne Schieldrop, Chief analyst commodities at SEB
Bjarne Schieldrop, Chief analyst commodities, SEB

The Brent crude August contract has had a great run from its lowest quote in late April of $22.45/bl to a close yesterday of $39.79/bl which is just below the 38.2% Fibonacci retracement level. The rally has been supported by both a revival in demand as well as a sharp reduction in supply. Both of these two forces are now being placed into question. US shale oil players are contemplating a reopening of shale oil wells which were closed when demand and prices crashed. OPEC+ is scheduled to bring back supply from July unless current discord can be overcome while recent demand indications in the US published this week were weakening for a third week in a row with total products delivered down 22.5% YoY. There is thus quite a bit of headwind right now to propel the Brent crude oil price above and beyond the $40/bl line for now.

All eyes are now naturally focused on OPEC+ and their deliberations over what to do in July. Reduce cuts from 9.7 m bl/d in May and June to 7.7 m bl/d in July and H2 overall as planned or roll current cuts of 9.7 m bl/d forward for an additional 1-3 months’ time. Saudi Arabia, Kuwait and UAE have also had an additional 1.2 m bl/d of above target cuts in June which might be cancelled in July.

Saudi Arabia and Russia indicatively seems to be willing to roll current cuts forward for another 1-3 months’ time but limited compliance to the agreement in April has become a significant stumbling block with Nigeria and Iraq the two biggest offenders. Unless these offenders can be reined in there is not going to be any forward rolling of current cuts of 9.7 m bl/d.

The proposed early OPEC meeting on the 4th of June has been ditched and now the originally planned meeting on June 9 to 10 is probably being shifted out in time to mid-June. This to review more data on compliance as Saudi Arabia is getting ready for hard-ball negotiations with OPEC-cheats. Without guarantees of full compliance Russia is unlikely to come along rolling cuts of 9.7 m bl/d forward into July. Not only are cheaters being pushed to fully comply with the deal going forward but they are also asked to make up for what they did not deliver in May and June by additional deeper cuts in July and August. That sounds like a very tall order. Our first instinctive reaction: this will never happen.

We don’t hold a strong view over whether current cuts of 9.7 m bl/d will be rolled forward for another 1-3 months or not. Maybe, maybe not. What we shouldn’t forget here is what happened on the 6th of March when Russia and Saudi Arabia fell apart as Saudi wanted to chase prices higher through further cuts while Russia was getting sick of cutting and just wanted to get back to business as usual. This underlying conflict is still there between the two parties in OPEC+ as it originates from the fact that Saudi Arabia has a presumed social break-even oil price of $80-85/bl while Russia’s is closer to $40/bl. As such they naturally get different goals and strategies with Russia favouring volume growth at an oil price in the range of $45-55/bl (if that is the oil price in a shale oil world) while Saudi Arabia unavoidably wants to chase prices to $60-70-80/bl through production cuts.

Saudi Arabia can and probably must at some point in time shift its social break-even oil price from current $80-85/bl and down towards $50/bl by increasing exports by 30-40% while cutting budget spending by 20-30%. This is also the messages that Muhammed bin Salman gave to Saudi Aramco and state departments following the break-down with Russia on the 6th of March this year. Though Covid-19, demand collapse and Donald Trump’s political pressure later forced Russia and Saudi to cooperate again.

Saudi Arabia and Russia’s interests are probably aligned as long as the oil price is below $40-45/bl, shale oil production is deteriorating while global oil demand is significantly below normal. But once we get to $50/bl, US shale oil wells are re-started, drilling rig count is ticking higher and global demand is moving closer to normal then we think that the dividing line between Russia and Saudi Arabia again is likely to re-emerge.

Russia is happy with an oil price around the $50/bl mark and wants to get its volumes back into the market again at such a price level rather than to see that US shale again starts to eat away at its market share.

It is very difficult for us to understand why OPEC+ agreed in late April to hold production cuts all to the end of April 2022. By doing so the group will give US shale oil producers all the time in the world to shape up, get bankruptcies out of the way and rebound production to the extent that oil prices allow it to do. This is the same recipe and the same mistake that OPEC+ did through 2017,18,19 when it held medium cuts for a long time. This gave US shale oil producers all the runway in the world to ramp up production. Getting its production cuts back into the market became forever impossible without crashing the oil price and Russia was caught in forever lasting cut agreement.

A much better solution would be to cut hard, deep and fast. As such we support a solution where current cuts of 9.7 m bl/d are rolled forward for another 3-6 months. But it should be coupled with the message that cuts will thereafter rapidly be placed back into the market through Q1/Q2 2021.

In this way US shale oil players will not have time to revive production other than to place closed wells back into operation. There won’t be a good reason to ramp up shale oil drilling and fracking either because OPEC+’ volumes will be placed back into the market again already in H1-2021.

As such we are inclined to believe that there is probably a better than even chance that OPEC+ will roll its current cuts of 9.7 m bl/d forward to July, August,.. rather than to reduce cuts down to the originally planned 7.7 m bl/d cuts.

For now oil prices are pulling back awaiting a decision by OPEC+. The Brent crude August contract could easily pull back towards the $35-36/bl level but would definitely rebound up and above the $40/bl line again if OPEC+ decides to roll the 9.7 m bl/d cuts forward beyond June. Stronger demand revival signals would also be welcome. They will come for sure. Peak oil demand? Not at all yet. We will move back up to 100 m bl/d again and above. Just a matter of time.

The Brent crude oil August contract closed just a fraction below the 38.2% Fibonacci retracement level yesterday. Now pulling back on weakness in US demand signals as well as awaiting a decision by OPEC+

Brent crude oil price
Source: Bloomberg, DOE

Total US products delivered has dissapointed now three weeks in a row. It all looked good in terms of demand revival until mid-May but since then it has been a sad story

Total US products delivered
Source: Bloomberg, DOE

It is deliveries of US mid-dist products which is the weakness here. That is typically diesel and jet fuel.

US mid-dist products
Source: Bloomberg, DOE

Deliveries of jet fuel in the US is still down 79% YoY. No solid signal of rebound yet there.

Jet fuel in the US
Source: Bloomberg, DOE

US crude oil continues to fall sharply in a combination of structural decline and deliberate shutting of wells. The underlying losses in US shale oil crude and NGL production in the US is in the range of 600 – 800 k bl/d per month. Currently there are only 222 active oil rigs in the US. These have an implied productive effect of about 165 k bl/d per month of new supply if all the wells they produce are placed into production (probably not done now). There is thus a significant ongoing structural decline in the US of up to 400 – 600 k bl/d per month today.

US crude oil continues to fall sharply
Source: Bloomberg, DOE

The Brent crude oil time spread of the 1 month minus the 6 month contract. The contango moved deeper than in 2009 but has come back faster. The front-month Brent contract has actually been in backwardation vs the second contract briefly in intraday trading lately. If cuts of 9.7 m bl/d are rolled forward beyond June then market is likely to move into deficit, inventories drawing down and poff we are back in backwardation.

The Brent crude oil time spread
Source: Bloomberg

The current set back in crude oil prices can provide yet another chance to purchase forward Brent crude for 2021 average delivery at very low, favorable price levels. We strongly advised our clients to purchase crude and oil products when the forward Brent 2021 contract traded in the range of $35-40/bl. We still view low-40ies as a very favorable level.

The current set back in crude oil prices

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