Scraping the Barrel
The market is reacting favorably to expectations OPEC+ will extend its agreed-upon May/June production quotas for a further two months at its upcoming virtual meeting. The short extension of the deepest initial phase of the production cut agreement maintains a reduction at 9.7 mb/d and will assure markets rebalance in Q2 and simultaneously boost oil prices.
The oil rally continues, helped by more positive news on supply and the expectation that the upcoming OPEC+ meeting should be a positive catalyst. Russia reportedly cut crude production to 8.49-8.74mb/d in May (with uncertainty stemming from the fact that Russia does not break out condensate production exempt from OPEC+ cuts), close to the 8.5mb/ it agreed for May and June under the new OPEC+ agreement.
Speculation is centering on the duration of the extension, which could fall between 1-3 months of compliance to the current levels rather than a phased easing of cuts from July 1 as originally planned. The market will act more favorably on a three month surprise but could react conflictingly to a one month extension. Regardless, the meeting will be a success if the Russians and Saudis show evidence of their commitment to coordinated action, whether through a one, two, or three-month agreement extension.
It would be detrimental for sentiment if an extension is not agreed, but not particularly material from a fundamental perspective. Setting aside the rise in US inventories last week due to the offloading of cargoes from the Saudi Armada, recent data has been more optimistic from both supply and demand than initially anticipated. Indeed, surprisingly resilient demand post-lockdown and faster-than-expected production curtailments from outside the OPEC+ pact could be set to push the oil market into deficit in weeks, not months.
This meeting is expected to be brought forward one week to June 4. However, the challenge for OPEC+ is the availability of hard data to judge the market in terms of OPEC+ compliance and non-OPEC production curtailment or underlying demand recovery.
A survey by Bloomberg estimates that OPEC cut production by 5.84mb/d in May to 24.6mb/d, implying 77% compliance to the OPEC+ agreement. Saudi Arabia cut by 2.89mb/d to 8.7mb/d. Compliance from Iraq and Nigeria was low at 42% and 34%, respectively. An earlier survey by Reuters found a similar level of overall compliance at ~74% (Bloomberg, Reuters).
Whenever the meeting takes place, it will be necessary for the group to avoid any signs of bickering that may spook markets. Under-compliance by Iraq and Nigeria is unhelpful, but the main focus will be on Russia and Saudi Arabia – cuts from the behemoths account for more than 50% of the targeted reduction through April 2022.
Russia will be looking over their shoulder should WTI rapidly set sights on $40 per barrel. A further rise in WTI may encourage some US shale producers to turn the taps back on from a more favorable break-even perspective. US shale producers’ historical dexterity to price moves suggests US producers can be highly reactive to price moves as far as ramping up and down production.
The information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.
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