(Bloomberg Opinion) — OPEC+’s surprise oil production cut sent shockwaves through financial markets and sent crude prices to the highest in a year. Now that the dust has begun to settle, a big question arises: Will that price rally hold or fade?
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Banks from Goldman Sachs Group Inc. to RBC Capital Markets LLC raised their oil price forecasts immediately after the OPEC+ cut. However, many traders still believe that a sour economic outlook will prevent the group’s shares from driving prices higher. Demand indicators are also starting to show warning signs.
It could end up being the ultimate test of what is more important to the market: tighter supplies or a lackluster demand picture. That is likely to create more uncertainty about the direction of prices, a tricky development for the Federal Reserve and the world’s central bankers in their ongoing battle against inflation.
“It’s a very difficult market to trade right now,” said Livia Gallarati, a senior analyst at Energy Aspects. “If you’re a trader, you’re stuck between what’s going on macroeconomically and what’s going on fundamentally. They are two different directions.”
Read more: OPEC+ shock cut aims to make oil speculators think twice
One thing is certain: a major shift in market control from Saudi Arabia and its allies is now entrenched, with enormous implications for geopolitics and the world economy.
Investors have continued to reward US drillers for their production discipline, making it unlikely that shale companies will resume the kind of disruptive growth that helped keep energy inflation in check over the past decade. That leaves the oil market under OPEC+ control at a time when some experts have forecast demand headed for a record.
“OPEC’s surprise cuts have already triggered fears of a resurgence of inflation,” said Ryan Fitzmaurice, lead indices trader at commodities brokerage Marex Group Plc. “These renewed inflation concerns should only increase” in the coming months, he said.
Here is an overview of what traders will watch in the oil market.
summer demand
The timing of OPEC’s decision has struck a chord with many oil experts.
Production cuts don’t take effect until May and much of the repercussions are likely to be felt in the second half of the year. That’s a time when oil demand typically hits its seasonal peak, thanks in part to the busy summer driving season in the US. It’s also the point at which China’s economic reopening is expected to begin. to run at full speed, which will further support demand.
OPEC would generally want to take advantage of that explosion in consumption by selling into the market as much as possible. Instead, the outage means the cartel is holding back. That’s sparking a debate about whether the move will end up pushing oil prices to $100 a barrel as demand picks up, or whether, instead, the cartel and its allies are bracing for a tepid consumer summer marked by recession.
“While OPEC+ acreage cuts are generally seen as bullish, it also raises concerns about the demand outlook,” said Warren Patterson, ING’s head of commodity strategy. “If OPEC+ were confident of a strong demand outlook this year, would they really feel the need to cut supply?”
Movements in world fuel markets underline demand skepticism. While oil prices rose, movements in refined products were less pronounced, depressing refiner margins in Europe and the US. In Asia, prices for diesel, a key refinery product, are signaling a further concern over slowdown as time frames shrink to their lowest level since November.
high reserves
While US inventories have declined, global inventories remain high.
In the first quarter, commercial oil reserves in OECD countries were 8% above last year’s levels, according to estimates by the US Energy Information Administration. That’s a pretty hefty cushion and a sign of the weakness in consumption that has affected the market in recent months.
“It needs to chew through that ledge first before we can see we’re up,” said Gallarati of Energy Aspects.
russian flows
Oil bulls have waited in vain for a promised Russian production cut to appear in March. The Kremlin said it would cut production by 500,000 barrels a day in March in retaliation for import bans and price ceilings imposed by “hostile countries.” But there has been no sign of lower Russian production in the only measure that matters for world crude markets: the number of barrels leaving the country.
Crude shipments from Russian ports hit a new high in the last week of March, topping 4 million barrels per day. That is 45% higher than the average seen in the eight weeks before Moscow troops invaded Ukraine and has been buoyed by the diversion since January of some 500,000 barrels a day delivered by pipeline directly to Poland and Germany.
Shale production discipline
Not too long ago, there were two main players that oil traders turned to for supply guidance: the Organization of the Petroleum Exporting Countries and the US shale industry.
At the time, OPEC and shale were locked in a battle for market share. It was a dispute that helped keep global oil prices and energy-fuelled inflation in check for most of a decade.
Then came the pandemic, and with it a drop in the price of oil that choked the shale industry. For the past three years, even as the market recovered and cash flow increased, companies prioritized dividends and share buybacks over new drilling. It has been a winning strategy. Since March 2020, the S&P 500 Energy Sector Index is up nearly 200%, outpacing the S&P 500’s nearly 60% gain.
Now, as peak production orders for shale rise, OPEC has one less factor to consider when making supply decisions.
That’s a sore spot for President Joe Biden, who has been quick to downplay the impact of the cartel’s and its allies’ decision to cut production by more than 1 million barrels a day. Biden promised after an initial production cut last year that there would be “consequences” for Saudi Arabia, but the administration has yet to deliver.
Read more: Investors dumped Saudi Arabian bonds after surprise OPEC+ move
futures curve
There has been talk of $100 oil since late last year, but it looks like the can is still getting kicked down the road. First, some analysts had forecast that prices would hit that threshold in the second quarter of 2023. The outlook has been pushed back to the second half of the year, and now even some of the biggest bulls don’t expect the magic number to kick in until 2024. .
The oil futures curve is reflecting those expectations. Prices for contracts tied to deliveries through December 2024 and 2025 have skyrocketed, even as the previous month’s benchmark futures are starting to decline.
“The OPEC+ production cut certainly raises the possibility of $100 a barrel this year, although it is by no means a certainty,” said Harry Altham, an analyst at brokerage StoneX. “Demand-side weakness stemming from growth considerations is clearly taking a more prominent role.”
–With assistance from Julian Lee, Grant Smith, Chunzi Xu, Kevin Crowley, and Mitchell Ferman.
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