A daily gain of 50-60 cents/bbl on the crude oil futures contract might not be eye-catching but when yesterday’s performance is put in context one can only conclude that the price strength was rather encouraging. It came despite the temporary support from last week has been withdrawn. Traffic in one of the most critical arteries of global trade resumed as Ever Given, the now infamous container ship has been freed. It will take time to clear the backlog as over 400 vessels have been held up by the incident. The impact on global supply chain will be felt for weeks to come. But the price reaction, apart from an intra-day drop, was positive and it can be a sign that the worst of the correction is over. Those with bullish inclination also took heart from the strengthening of the crude spreads. The May/June WTI spread is shaking off the contango blues and the June/July Brent price differential, which will become the prompt spread after Wednesday’s settlement, rallied 7 cents/bbl on the day.

Oil was also dismissive of the continuous rise in Covid cases, stock market turbulence and the strong dollar. The virus is still running amok in most of Europe and India, and hospitalization is on the rise again in several US states. Bank shares came under pressure as stock markets have been shaken by the fire sale of Chinese and US stocks by an investment firm that led to margin calls and warnings of significant losses from Credit Suisse and Nomura, that were providing prime brokerage services to Archegos Capital Management. The factors that triggered the profit-taking in oil in the past 2-3 weeks (demand considerations, equity fluctuation and the stubborn greenback) are still very much alive and kicking. Yesterday’s resilience might imply that although the uptrend we saw in the first two months of the year could take longer to resume, the bottom has been found. Bulls, who were shepherded through the door lately may start sneaking back to the playing field.

Rolling, rolling, cutting?

Last time OPEC ministers and their colleagues from the ten non-OPEC producer nations concluded their video meeting on March 4 front-month Brent settled just below $67/bbl. The group surprised the market by deciding to continue with the March production level, the only exceptions being Russia and Kazakhstan who have been allowed to slightly raise output. Saudi Arabia provided the real bullish impetus by extending its voluntary 1 mbpd constraint into next month. Two days later the European benchmark peaked above $71/bbl, partially helped by the Houthi drone and missile attacks on Saudi oil facilities located at the Persian Gulf. The following few days saw prices shifting sideways and this lack of upside potential, the result of strong dollar, relentless rise in Covid infections, vaccine nationalism and the consequent worries about economic and oil demand growth in the foreseeable future, triggered a change in sentiment. Brent dropped close to $60/bbl although the recent price rise could be a confidence booster.

It is this backdrop against which the producer group will decide its market management strategy this Thursday, probably for the next month and maybe beyond. There are obviously three possible outcomes of the ministerial meeting: increase production, maintain output cuts, or reduce supply. Ministers will be well aware that global oil consumption in the second quarter of the year will not grow at the pace it was expected a month ago. OPEC’s research team will also be keen to point out to decision makers that demand from China, the engine of growth, is taking a temporary hit. Apart from the upcoming refinery maintenance the backwardated nature of the Brent market has also made it more economic to draw on storage as opposed to participate in the spot market. They will also note that increased Iranian exports to China has to be dealt with.

Global oil demand was forecast to stand at 95.61 mbpd in the upcoming quarter, according to the latest OPEC monthly report. This estimate will surely be revised downwards when the updated projection is released in the middle of next month. Despite the recent sell-off, average prices in the current month are likely to be higher than in February and this could lead to an upward amendment in non-OPEC supply. The call on OPEC in 2Q, which was estimated to be 27.40 mbpd two weeks ago will probably be below earlier projections. It will still be high enough for global and OECD stocks to deplete even if the producer group decides to increase its production, but in a market that is so often driven by sentiment and perceptions such a move would certainly encourage bears. Under the current circumstances, this option would not be vindicated and therefore is implausible.

Which leaves us with two other choices: leaving production unchanged for at least May or possibly even for June or double down and cut further. Probably the former is built in the prices, this is what the market anticipates, and this is what unnamed sources close to the group are suggesting. Given the immediate demand destruction, the potential increase in non-OPEC supply, the revival of Iranian exports and Russia’s intention of seeking another small rise in its quota rolling output over to May would slow down 2Q stock draw that was pencilled in at 1.70 mpbd in the middle of March and would act as a break on the re-balancing process.

To at least match the above projection the producer group ought to reduce its output further and Saudi Arabia must be willing to keep its additional 1 mbpd voluntary reduction in place, which, reportedly, they are prepared to do. This would automatically lead to the erosion of the market share of the producer group and would unlikely push prices back to recent highs. It would, however, send out yet another re-assuring signal to the market and will form the base of a rally over the recent peak when demand outlook improves. That would be the time to start gradually re-claiming the share of the market that has been lent to producers outside OPEC+ over the past year or so. If the UAE’s plan to cut supplies by 5% in May and by 15% in June is any hint of what the producer group might come up with, the possibility of further constraints, however unlikely at the moment, should not be discounted.