This Week In Oil - April 13, 2020

Sell the rumour, sell the news?

Let’s summarize last week in one sentence. The OPEC+ agreed on production cuts and this will have no long term effects on prices.

The issue is that those cuts are not material. Given the level of production and the lack of demand natural market forces are forcing this decline. There is nothing unexpected in this announcement. There is nothing positive for prices past the knee jerk reaction we’ll get after the announcement.

The problem for oil prices is demand. And as long as we have an ongoing pandemic crisis demand will stay low. And depending on the damage going on in the real economy the effect on demand could be long lasting.

What did OPEC+ agree on exactly?

After tooting early production cuts of 10 million barrels per day the agreed on number is now 9.7 million barrels per day. But from the average production levels at this time of the year the cut really amounts to 7.2 million barrels per day. 

Also with a price of twenty something dollars per barrel and with storage capacity filling up fast there is bound to be market driven production cuts anyway. So it doesn’t hurt to agree on production cuts that would happen anyway regardless of OPEC+.

Now for sure that is still a pretty large cut historically speaking. However the global demand is down 36 million barrels per day!

So the OPEC+ agreement does not count for much in the grand scheme of things:

  • Announced cut 9.7m bpd

  • Actual cut from seasonal levels 7.2m bpd

  • Global demand reduction 36m bpd

What can we expect for oil prices out of this? The OPEC playbook is the following:

  1. Create drama.

  2. Hype the market with timed announcements.

  3. Have the market rally while the hype lasts.

  4. Repeat step 1.

It is then likely that the market will rally after the announcement of the cuts. But this should fade quickly after the hype goes away. The futures will go back down towards $20 per barrel soon enough.

Any rally is a good occasion to short now. You just have to look at the term structures on WTI futures to see that the oil market is still in super contango. Storage continues to be tight. Production is way too high relative to the demand. These are realities that are not getting changed by the OPEC+ cuts.

WTI futures price curve

Demand fell off a cliff in March. This was sudden and somehow not anticipated by the market. As a result prices went down quickly too. But production needs some time to adjust to the new conditions. The response is lagging and it will take some time for production to catch up. 

For now production levels remain high even in the US and storage is getting filled fast. Just take a look at the EIA US oil weekly stock change report:

  • Build of +15 million barrels

  • 3.4 sigma stock change

In normal conditions this would have sent WTI crash down immediately. But given the extraordinary circumstances the futures market barely reacted to the report.

EIA Stock Change April 08, 2020EIA Crude Oil Stock Change distribution, April 08, 2020.

US producers have been cutting on production though. The rig count is continuing to fall at a very rapid pace. Three more weeks at this rate and we’ll be down to levels last seen at the bottom of 2016.

Rig count April 09, 2020

On Monday morning prices are trending higher following the final OPEC+ agreement. News headlines of a “historic cut” and the “end of the Russia vs Saudi Arabia price war” are going to drive prices higher at the beginning of this week. Especially with the thin volumes to be expected on the Easter Monday. 

WTI after OPEC+ Sunday agreement

But stay put for reality coming back to the market with prices to retest $20 per barrel.