Welcome to the OPEC+ edition of Oil Markets Daily!
Europe is locking down, causing the oil market to sell first and ask questions later. And as we have explained time and time again, this time is very different than March when the whole world was going into lockdown. This time around, China and India’s demand are seen rebounding higher year-over-year and China’s floating storage backlog will be gone in two-weeks.
With the Chinese government also issuing 20% more import quota for the independent refineries in China totaling ~4.9 mb/d, you can expect some type of frenzied buying into year end.
So while the oil market is selling first and asking questions later, the current sell-off is not only too much, but we suspect oil prices will reverse $6-$10/bbl higher in the short term. One of the catalysts will be the notion that OPEC+ agrees to extend the current ~7.7 mb/d cut for an additional three months.
What’s the probability of this? We would assess it at over 80%.
So why the confidence in this call? Well, for starters, Russia, the usual culprit for never wanting to cut oil production, has a few things on its plate this time around.
- Russia insisted back in March that the US join in on the production cut and with visibility in the production decline in the US (visible of ~1.7 mb/d cut) and the collapse in rig count, Russia won’t feel slighted for enduring another three months worth of cut.
- European oil demand is the one that’s being directly impacted here which influences half of Russia’s oil sales. And since those crude exports are in the form of pipeline exports, if refineries choose to buy less, Russian companies will export less. This means that they should have no objections to extending three months, especially if the demand weakness is in Europe this time.
- Saudi Arabia’s big market share is in Asia and with India shining bright again and Russia having no cheap access to ship crude to India, Saudi Arabia won’t hesitate in extending the production cut. Demand regions are going to buy all of its crude, and with competitors struggling, there’s no pressure on the physical side.
This is why you are now reading headlines coming from the Russians talking about the possibility of an additional three-month extension. In the history of OPEC+ meetings, this is probably the weakest hand the Russians ever held going into a meeting. The Saudis know they want the cut to be extended now, so if they are intending to push oil inventories down, they wouldn’t hesitate to agree.
As for the rest of OPEC+, they really don’t have much say. Iraq, being the one outlier, can’t stomach another oil price war with the Saudis. So either they can commit to an additional three month or feel the wrath of the Saudis, a scenario no one really wants to entertain.
The oil market is likely going to start pricing in some type of probability of this. From the traders’ perspective, an additional three-month extension may only merely wipe out the demand loss seen in Europe, although we’ve done the calculation on this, it’s far from true. Vitol traders already said over the weekend that demand hit will be less than ~1 mb/d and with IEA forecasting draws close to ~5 mb/d in Q4, that’s only going to dent the recovery.
Either way, if the market gets a whiff of an extension, expect Brent to quickly recover back to $45/bbl. We think the odds are highly favoring an additional three-month extension.
HFI Research, #1 Energy Service
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