After a drop of more than $10/bbl it is not unusual to see some kind of technical rebound. Any positive development will get a bigger attention than it otherwise would deserve, and shorts will feel tempted to cover. It was clearly the case yesterday as WTI recovered $3.23/bbl and closed at $34.36/bbl. Brent was lagging somewhat behind as it strengthened $2.86/bbl to settle at $37.22/bbl. The relief rally was partly down to the stock market performance. The main US stock indices jumped nearly 5%. The US President will reportedly ask the Congress for a fiscal stimulus package that would include a payroll tax cut. Targeted response that helps industries hardest hit by the virus is also under discussion.

On the oil front producers are seriously considering spending and drilling cuts in the light of the recent price fall. This raises the hope of tighter supply. However, as with all things, timing is everything. Any reduction in spending and drilling will take time to show up in actual production figures and is unlikely to mitigate the bearish impact of a massive Saudi output increase, in case the latter does happen.

This morning follow-through buying helped oil prices recover further. Although the API showed a bigger-than-expected build in crude oil stocks (6.4 million bbls versus a forecast of 2.3 million bbls) product stocks have dropped sharply. Gasoline drew 3.1 million bbls and distillate by 4.7 million bbls. The morning strength did not last as the Aramco CEO, after announcing a supply hike to 12.3 mbpd in April yesterday, said this morning that his company was instructed by the Ministry of Energy to increase production capacity from 12 mbpd to 13 mbpd.

Testing times

Headline traders had a field day yesterday morning. Front-month Brent was trading around $37/bbl at 9 am London time as prices were gradually strengthening in the hope that fiscal and monetary stimulus would provide much needed support for the ailing global and regional economies. Then the headline about increased Saudi production emerged. The CEO of Aramco, Amin Nasser said that his country’s production will increase to 12.3 mbpd in April. This would be a jump of about 2.6 mbpd on February. The stage, all of a sudden was set to test Monday’s lows and the new technical downside targets of $26/bbl and $27/bbl started to look realistic.

Oil prices dropped nearly $2/bbl in the space of 25 minutes when the Russian energy minister, Alexander Novak hinted at the resumption of co-operation with OPEC in order to stabilize the oil market. The Kremlin threw its weight behind this claim by stating that the resumption of negotiations was still very much on the table. Russia also floated the idea of an OPEC+ meeting in May or June, something that was rebuked by the Saudi energy minister. Intra-day shorts covered, and they even started building up length. The market went back where it fell from and even higher within less than two hours and stabilized at those levels for the rest of the day.

Whom should we believe? Statements and promises have been controversial over the past four days. The Saudi-Russian alliance seemed to have been falling apart and oil prices were on their way to sub-$30/bbl levels. Was Monday’s price crash a sobering experience for Russia that its decision to refuse additional output cuts was a premature step? Is Saudi Arabia serious about ramping up production and its export to levels not seen for a long-time? Or is what we are experiencing now is a live test of the market’s pain threshold? It will take a few weeks to find the answers to the above puzzles. In the meantime, let us assume two extreme scenarios based on Monday’s Oil Market Report from the IEA. In the first one the feuding parties make up and an agreement is eventually struck within the OPEC+ group to cut production by the originally proposed 1.5 mbpd. In the second scenario the pre-2017 status quo is re-established and OPEC+ members return to their pre-agreement output levels with the Saudis pumping as much as promised yesterday.

It must be reiterated that demand for OPEC oil is now set to be 25.00 mbpd in 1Q, 26.90 mbpd in 2Q and 28.65 mbpd in the second half of the year. There is not much that could influence the first quarter of the year, global oil inventories will have increased over 3 mbpd. An extra 1.5 mbpd reduction would take OPEC production down to around 27.30 mbpd and the non-OPEC ceiling to 48.80 mbpd. It should be just about enough to balance the market for 2Q and as such it would be price supportive from the current price levels. To be clear, the absolute balance would not be bullish, global stocks would not draw but sub-$40 oil prices would probably be avoided. A rally back to $50/bbl would be a reasonable expectation. We suspect that even if the parties get together as soon as possible, one sticking point would be the duration of the new cuts. OPEC would probably insist on running it till the end of the year whilst Russia would want to go for the end of June termination.

Under the second scenario all hell would break loose. If Saudi Arabia really ramped up its output to 12.3 mbpd, the rest of the group went back to the pumping as much as they can and the non-OPEC countries also increased production by 0.8-1 mbpd the price shock would be unbearable for smaller producers, even for a few months. Under this scenario we would expect a sharp drop well below the $30/bbl mark, which would be followed by a gradual recovery as OPEC+ members would likely strike some kind of deal and non-OPEC production growth would also be revised down.

Brent settled at $37.22/bbl yesterday, some $12bbl above $25/bbl level, mentioned on a frequent basis in recent days. Where do you think the next $12/bbl will be? Down to $25/bbl or up to $50/bbl? It is impossible to answer. The oil market has been at its most unpredictable self in recent months. We started the year in an optimistic mood thinking that a trade deal, struggling US shale coupled with OPEC+ discipline will support prices. After the virus outbreak became a global epidemic, we had to revise down our 2020 oil price estimate. During the run-up to last week’s OPEC+ meeting we were convinced that, based on the proposed 1.5 mbpd cut, the market will stabilize around the $50/bbl level but will not go back up to the $65/bbl area any time soon. The Russian reluctance followed by the Saudi retaliation provided a new twist. A fall below $30/bbl looked inevitable. Rhetoric, however, helped the oil market recover some from Monday’s slump. So, what’s now? The Russian or Saudi energy ministers might know, we don’t. If someone held a gun to our head forcing us to vote we’d say a fall below the $30/bbl is plausible if Saudi Arabia does, in fact, increases production as indicated. And it is a big IF.