Devika Krishna Kumar and Alex Longley
OPEC+’s surprise oil-production cut sent shock waves through financial markets and pushed crude prices up by the most in a year. Now that the dust has started to settle, one question looms large: Will that price rally stick, or fade away?Banks from Goldman Sachs to RBC Capital raised their
oil-price forecasts immediately after the OPEC+ cut. Yet, many traders still
believe a souring economic outlook will block the group’s actions from pushing
prices higher. Demand indicators are also starting to flash warning signs.
It could end up being the ultimate test of what matters more
to the market: tighter supplies, or the lwacklustre demand picture. That will
likely bring more uncertainty over the direction of prices – a complicated
development for the US Federal Reserve and the world’s central bankers in their
ongoing battle against inflation.
“It’s a very hard market to trade right now,” said Livia
Gallarati, a senior analyst at Energy Aspects. “If you’re a trader, you are
pulled between what’s happening at a macroeconomic level and what’s happening
fundamentally. It’s two different directions.”
One thing that is certain: A major shift of market control
into the hands of Saudi Arabia and its allies has now been cemented, with huge
implications for geopolitics and the world’s economy.
Investors have continued to reward US drillers for
production discipline, making it unlikely that shale companies will ever again
undertake the kind of disruptive growth that helped to keep energy inflation
tame last decade. That leaves the oil market under the purview of OPEC+ at a
time when some experts have predicted that demand is heading to a record.
“The surprise OPEC cuts have already triggered fears of a
resurgence in inflation,” said Ryan Fitzmaurice, a lead index trader at
commodities brokerages Marex Group. “These renewed inflation concerns should
only increase” in the months ahead, he said.
While OPEC+ cuts on the surface are generally seen as
bullish, it does also raise concerns over the demand outlook. — Warren
Patterson, head of commodities strategy, ING
Here is an overview of what traders will be watching in the
oil market.
Summer demand
The timing of OPEC’s decision has struck an odd chord for
many oil experts.
The production cuts don’t take effect until May, and much of
the repercussions are likely to be felt in the second half of the year. That’s
a time when oil demand typically reaches its seasonal peak, partly due to the
busy summer driving season in the US. It’s also the point when China’s economic
reopening is expected to start swinging into full gear, further underpinning
demand.
Typically, OPEC would want to take advantage of that
consumption burst by selling into the market as much as possible. Instead, the
cut means the cartel is holding back. That’s sparking debate about whether the
move will end up driving oil prices to $US100 a barrel as demand surges, or
whether, instead, the cartel and its allies are preparing for a
recession-marked summer of tepid consumption.
“While OPEC+ cuts on the surface are generally seen as
bullish, it does also raise concerns over the demand outlook,” said Warren
Patterson, head of commodities strategy at ING. “If OPEC+ were confident in a
strong demand outlook this year, would they really feel the need to cut
supply?”
Moves in global fuel markets underscore the demand
scepticism. While oil prices rallied, moves for refined products were less
pronounced, shrinking margins for refiners across Europe and the US. In Asia,
prices of diesel, a key refinery product, are signalling heightened slowdown
concerns as timespreads shrink to their lowest since November.
Elevated stockpiles
While US inventories have been declining, global inventories
are still high.
In the first quarter, commercial oil stockpiles held in OECD
countries were sitting about 8 per cent above last year’s levels, according to
estimates from the US Energy Information Administration. That’s a fairly
sizeable buffer and a sign of the weakness in consumption that’s plagued the
market in the past few months.
“You do need to chew through that overhang first before we
can see we upside,” said Ms Gallarati of Energy Aspects.
Russian flows
Oil bulls have waited in vain for a Russian output cut
promised for March to show up. The Kremlin said it would slash production by
500,000 barrels a day in March in retaliation for import bans and price caps
imposed by “unfriendly countries.” But there’s been no sign of lower Russian
output showing up in the one measure that matters to global crude markets – the
number of barrels leaving the country.
Crude shipments from Russia’s ports hit a new high in the
final week of March, topping four million barrels a day. That’s 45 per cent
higher than the average seen in the eight weeks before Moscow’s troops invaded
Ukraine and has been boosted by the diversion since January of about 500,000
barrels a day delivered by pipeline directly to Poland and Germany.
Shale’s production discipline
It wasn’t long ago that there were two major players that
oil traders turned to for direction over supplies: OPEC and the US shale
industry.
At the time, OPEC and shale were locked in a battle for
market share. It was a feud that helped to keep global oil prices – and
energy-driven inflation – at bay for the better part of decade.
Then the pandemic hit, and with it an oil price rout that
suffocated the shale industry. For the last three years, even as the market
recovered and cash flow surged, companies have prioritised dividends and share
buybacks over new drilling. It’s been a winning strategy. Since March 2020, the
S&P 500 Energy Sector Index has surged almost 200 per cent, outpacing the
S&P 500’s nearly 60 per cent gain.
Now, as calls for peak shale output gather pace, OPEC has
one less factor to consider when making supply decisions.
That’s a sore spot for US President Joe Biden, who was quick
to downplay the impact of the decision by the cartel and its allies to cut
output by more than one million barrels a day. President Biden vowed after an
initial production cut last year that there would be “consequences” for Saudi
Arabia, but the administration has yet to follow through.
Futures curve
Talk of $US100 oil has been buzzing since the end of last
year, but it seems like the can keeps getting kicked down the road. First, some
analysts had predicted prices would reach that threshold in the second quarter
of 2023. The view got pushed into the second half of the year, and now even
some of the bigger bulls aren’t expecting the magic number to come into play
until 2024.
The oil futures curve is reflecting those expectations.
Prices for contracts tied to deliveries as far out as December 2024 and 2025
have rallied, even as benchmark front-month futures are starting to ease.
“The OPEC+ output cut certainly raises the possibility of
$US100 a barrel this year, although it is by no means a certainty,” said Harry
Altham, an analyst at brokerage StoneX. “Demand-side weakness stemming from
growth considerations is clearly taking a more prominent role.”
With assistance from Julian Lee, Grant Smith, Chunzi Xu,
Kevin Crowley and Mitchell Ferman
Bloomberg