We were supposed to get a firm decision on whether the OPEC cuts would be rolled over or expire on November 30th, but due to further consultation the decision had been put on hold until December 3rd. Now the market awaits the key decision by the main OPEC members including Russia as to whether to keep the 7.7 mbpd of Oil cuts in place for a few more months or let everyone go back to producing as normal economics dictate - true and open market. Brent Oil price has rallied 28% since the November post-election lows, what can this meeting mean for the Oil price going forward?
Just to refresh memories, back in April when Russia decided to play hard ball with Saudi Arabia and not cut their Oil production, Saudi Arabia decided to call Russia's bluff and let Oil prices collapse. We even went to negative pricing as there was just too much Oil in a very short space of time, and the physical market was paying you to take Oil off their hands as there was no space to store it. This was quite an anomalous situation as at a time when the world had ground to a halt, literally zero demand for anything, and Saudi Arabia decided to flood the world with even more Oil. In hindsight, this was seen to be a major mistake as no one really took the Covid demand collapse seriously, and the structural changes to demand there could be. It was at that time when all players including Russia and even U.S. shale were hurting, so they brokered a deal to take off about 9.9 mbpd of Oil out of the market to support the demand collapse. These cuts have been rolling since that time, hoping to buy the Oil market some time to recover as the world reopens and goes back to normal. Now it is almost at the end of the year, and we are still nowhere close to going back to normal oil demand levels. Prices have risen close to $48/bbl. Brent, a respectable level, and a lot of the members were told not to produce before they get more and more anxious to make up for lost revenues.
OPEC and its members have a bit of a dilemma as each country has its own government spending and deficit considerations. Even though the cost of their Oil may be around high single digits, most of these countries have breakevens closer to $55/bbl. Brent, plus to balance their spending plans. Saudi Arabia needs Oil prices close to $80-$85/bbl. to breakeven on their plans, even though their cost of Oil is less than $3/bbl. Russia is happy to keep producing as long as prices are $50-55/bbl. Brent and above. So, clearly each country has different stress points, hence the contention on reaching a consensus. Then you have countries like Iraq overproducing 600k bpd and Russia overproducing 530k bpd. How do you control that?
Sadly enough, the oil market today needs these 7.7 mbpd of Oil out of the market still, so the group needs to get all the members on board to convince them it is the right thing. If they get the roll over through Q121, then Oil prices stays around here capped at $50/bbl. Brent, give or take. We know the vaccine will not be in place till April at the earliest in terms of full distribution and logistical hurdles. Then again, to be comfortable to travel fully again and no restrictions, we could be a year away. Keeping Oil on the sidelines just buys time hoping that all the stimulus being pumped in the economy makes up for the demand short fall in jet fuel, but higher in other manufacturing areas of Energy. Whether we like to admit it or not, there is no shortage of Oil. If these cuts are not rolled over, Oil prices can easily fall back down to mid $30s, where it was prior to the vaccine related good news that was released in November.
Commodities are all about inventory balances, despite your views of inflation and stimulus going forward. We have just normalized, inventories are no longer in massive surplus, but we still have 7.7 mbpd of Oil sitting on the sidelines waiting to come back. This is the reason why the price of Oil is flat with risks to the downside now that the vaccine related reopening has been priced in. But we are far from a tight market.
Going forward in the next year, if U.S. Shale is not able to go back to its peak, which will be hard given cash constraints, and demand normalizes, we can build a case for Oil gradually moving higher. But not now. For now, there is better value elsewhere in the Commodity space to play the inflation theme mixed with much tighter physical market fundamentals.
