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Vladimir Zernov
Crude Oil

Oil Video 01.05.20.

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OPEC+ Production Cuts Begin

May 1 marks the beginning of the OPEC+ production cut deal. Recently, Norway decided to join oil production cuts and it is widely expected that other non-OPEC+ countries will also cut production whether organically or through coordinated action.

From now on, the main focus is on compliance with the previously announced deal. The two biggest contributors to the production cut deal are Saudi Arabia and Russia. Saudi Arabia has the technological opportunity to quickly adjust its oil production both to the upside and to the downside. Russia does not have this luxury due to climate and the nature of its deposits.

In this light, Russia’s compliance with the deal will be in spotlight since the country may have trouble implementing a huge production cut deal in a quick fashion.

I’d note that demand disruption is so big that oil producers fully understand the necessity to cut production and I won’t expect cheating on this front – only technological problems will stand on the way of the implementation of the deal.

Estimating Oil Demand Is More Art Than Science Right Now

The disruption brought by coronavirus is so material that oil experts have trouble evaluating the actual hit to oil demand, especially in the short term.

For April 2020 – May 2020, most estimates of the hit to demand range between 20 million barrels per day (bpd) and 30 million bpd. The whole OPEC+ deal calls for cuts of 9.7 million bpd, so a 10 million bpd spread between various estimates makes it impossible to correctly predict the impact of the production cut deal on the physical oil market.

The market will have to operate amid this unprecedented uncertainty, and oil traders will have to watch the pace at which global oil storage fills to evaluate the actual decline in oil demand.

At this point, a rapid recovery of demand for oil does not look likely because all countries will be implementing a gradual exit from strict virus containment measures.

The futures market shares this view as WTI December 2020 futures are trading below $30 per barrel. I’d note that the spread between monthly contracts has narrowed, and traders expect a gradual upside in oil prices. In fact, the WTI December 2021 contract is trading below $34 as I write these words.

The futures’ market opinion may change quickly but it is obvious that the road to higher levels won’t be easy for oil unless we see a rapid rebound in oil demand.

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