Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Crude oil’s continued recovery challenged by quota-cheating
Ole Hansen
Head of Commodity Strategy
Summary: Brent crude oils return to a 40 dollar handle has so far proven to be short-lived. During the past week the oil market has moved higher in the belief that the OPEC Plus group of producers at their virtual meeting Thursday would extent a deal to curb production. Once again however the problem regarding cheating has emerged. With Russia, for a change, being close to full compliance the group has become much more reluctant to accept cheating from others, especially Iraq and Nigeria
What is our trading focus?
OILUKAUG20 – Brent Crude Oil (July)
OILUSJUL20 – WTI Crude Oil (July)
XOP:arcx – Oil & Gas Exploration & Production
XLE:arcx – Energy Select Sector SPDR Fund (Large-cap US energy stocks)
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Brent crude oil’s return to a $40/b handle has so far proven to be short-lived. During the past week the oil market has continued to move higher in the belief that the OPEC+ group of producers would extent a deal to curb production. Thereby continuing their support for the market while demand slowly recover.
Saudi Arabia and Russia, the leaders of the group, have preliminary agreed on a one month extension of existing OPEC+ cuts. The problem however is once again what to do with countries that fail to deliver the promised cuts. Moscow, usually a laggard in previous deals, has almost reached its target of 8.5 million barrels/day. That has left the group in a stronger position to demand compliance from others.
Among the OPEC producers Saudi Arabia and the UAE are top in class having cut the number of promised barrels. Nigeria and especially Iraq are still well behind and the OPEC+ group may insist that additional cuts for June and July may include what they failed to cut in May.
Once again the focus has returned to Iraq and Nigeria, OPEC’s notorious cheaters, who for years now have failed to deliver fully on any of the previous agreements. The lack of compliance since the first deal to cut production was struck in 2016 have up until now been quietly accepted. Not least due to involuntary production cuts during this time from Iran and Venezuela, and most recently also from Libya.
The reason why it’s different this time is due to the massive amount of pain that most producers are going through amid the dramatic Covid-19 related collapse in global demand. With Iran, Venezuela and Libya all scraping the bottom in terms of what they can produce, the other producers are simply not prepared to accept that Iraq and Nigeria continue free riding while others sacrifice market share and revenues.
OPEC+ can not afford not to reach an agreement with the current market price nowhere near the level many of the producers need to balance their budgets. On that basis we expect a deal of some sort will be reached, but the lack of compliance will leave the deal short in delivering its full price supportive potential. Not least considering news that US shale oil producers are slowly beginning to restart production after seeing the price of WTI return to profitable levels.
The technical outlook for Brent crude oil remains supportive above $37.30/b. Before the OPEC+ news broke the market had been focusing on the potential closing of the price gab to $45.18/b from March 6. The day when Saudi Arabia started their short-lived pump-and-dump strategy.
Later today at 14:30 GMT, the US Energy Information Administration will release their weekly inventory, trade and production report. Last night the American Petroleum Institute provided some additional support to crude oil after saying that nationwide stock levels declined by 0.5 million barrels, somewhat more optimistic than surveys pointing to a 3 million barrel increase.
While crude oil inventories are seeing a price supportive reduction amid slowing production and the renting of government controlled storage facilities to park unwanted oil, a challenge could be the risk of an emerging product glut. Distillate stocks are already elevated with refineries switching production to diesel instead of unwanted jet fuel. Gasoline stocks meanwhile have started to reduce but the risk remains that demand from US motorists may not recover fast enough to avoid stocks staying elevated.
Refineries will ultimately refine as much as possible as long it makes economic sense. Crack spreads, the profit being made from refining oil to products, are already at the seasonal lowest in more than ten years. The risk of reduced refinery demand for oil may present an obstacle to a continued price recovery.
As per usual I will post the results of the EIA report on Twitter @ole_s_hansen
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