Scraping the Barrel
Oil prices are trading off overnight tops after the API inventory report printed a much larger bearish to consensus build in crude stocks. At the same time, the relatively chunky distillate inventory print continues to suggest the demand rebound in the US is stalling. And while the draw in the gasoline inventory was more encouraging, it's a shoddy start to the day for Asia oil bulls as US oil inventories remain clogged, probably due to the supply overhang from the offloading of Saudi Armada cargoes.
Yesterday Brent succumbed nearly 4% following news that Saudi Arabia and its GCC allies will not extend around 1.2mb/d of additional voluntary supply cuts they had implemented on top of their commitments under the 9.7mb/d OPEC+ agreement. After getting assurances from non-compliant OPEC+ producers like Iraq and Nigeria, it seems likely Saudi no longer feels its over-compliance is necessary.
The slide in Brent most likely fits into the profit-taking category after an extended run for oil with no new fundamental data that would justify a shift in sentiment. The move lower was probably exacerbated by crude oil sensitivity to headline risk.
The overnight rebound
Oil prices rebounded on reports that SOMO, the Iraqi oil marketing entity, is already asking customers to voluntarily forgo cargoes contracted for June and July loading. This is a clear indication that Iraq may finally be taking the OPEC+ deal seriously and that pressure from Saudi Arabia and Russia are having its desired effects.
Prices are also getting further support from yesterday morning's newsflow indicating armed forces had ordered the Sharara field in Libya to shut down again just hours after the NOC lifted force majeure, putting in doubt the restart of production.
The principle of compensation
Iraq has asked some Asian refiners to consider forgoing prompt shipments of its Basra crude, raising speculation that OPEC's second-biggest producer is trying to comply with pledged output cuts. The country, along with some others, was recently taken to task by Saudi Arabia and Russia for pumping above their quotas.
The principle of compensation is a bullish game-changing factor as the hope that this rule will make the persistent under-compliance of the past a distant memory. Countries that show under-compliance during May/June – including Nigeria, Angola, Kazakhstan and Iraq – will now commit to a date when production will be brought into compliance and, more importantly, 'repay' excess production by over-compliance in the Jul-Sep period.
Macro backdrop needs to fall into place
But for oil prices to move higher, the macro backdrop will need to fall into place as US demand is still lagging. Oil demand remains weak in the US and big states that drive the US economy need to open with a driving boom. But, ultimately, without the return of travel between the world's three largest consumption regions – the US, EU and China – demand could still be slow to pick up.
But decisive for oil going forward is that OPEC+ substantial commitment and resolve appears solid enough to form the foundation of more constructive pricing. And so far US shale oil has remained relatively unresponsive to higher prices, suggesting prices may have to rise well beyond $40 to encourage US producers to ramp up production, owing to strong capital discipline in the US industry as a whole.
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Two-year yields have covered their prior six-month range in the last week alone – and whether or not this move is sustainable matters a lot