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STRICTLY AS AGREED

OPEC+ to increase oil production in August in anticipation of global economic recovery

Author:

01.08.2020

The implementation of the April agreements of the OPEC+ member states to cut oil production to remove the surplus from the market proved to be effective. Prices for benchmark brands have already exceeded $40 per barrel, and demand has begun to gradually recover. This encouraged the OPEC+ member states to adopt a decision to move onto the next stage of the deal - to increase production from August by 2 million barrels per day. But will the market welcome the decision with the same level of confidence, maintaining the current positive dynamics of price growth, or is it still a premature step?

 

Between war and friendship

In fact, production increase does not add optimism about the market reaction, although the participants do not see any particular problems and do not expect significant downward price changes. “We do not expect price decrease, for the market already adapted to the change. Currently the price holds at $40-43 and is more or less balanced," Russian Energy Minister Alexander Novak said.

Rystad Energy analysts claim that oil prices will fall sharply again in August. “Due to the production increase in August, the fall in demand may play a key role in bringing prices back to lower levels,” Louise Dixon, oil analyst at Rystad Energy said.

US President Donald Trump’s constant back-and-forth stance on China, changing from threats to friendly statements and vice versa also adds to the volatility of the oil market. Stock prices feel the pressure of news about the ongoing tensions between Washington and Beijing concerning the implementation of the first phase of the trade agreement between the two countries.

On July 22, the US authorities ordered the closure of the Chinese consulate in Houston, TX. President Trump told during the briefing that he did not rule out the closure of other Chinese consulates nationwide. In response, the Chinese Foreign Ministry announced on July 24 the closure of the US Consulate General in Chengdu, the capital of province Sichuan.

At the same time, Edward Moya, Senior Market Analyst at Oanda, notes that Donald Trump "needs a stronger economy and can't afford China not living up to the trade deal, so we are ultimately going to see this de-escalate eventually."

 

Full throttle

OPEC+ member states concluded a deal to reduce oil production after an unprecedented drop in oil demand due to the COVID-19 pandemic. According to the deal, at the first stage (in May-June) it was planned to reduce oil production by 9.7 million bpd, and then restore part of the reduced production in two stages at 2 million bpd.

In June, the ministers of the OPEC+ member states decided to extend the restrictions within the first stage for another month and, starting in August, move to the second stage of the deal. A number of experts expected that a new extension would follow in July, but it was decided not to deviate from the set course.

During the summit of the Joint Ministerial Monitoring Committee (JMMC) on July 15, Mr. Novak and the Saudi Minister of Energy, Prince Abdulaziz bin Salman, stated that the oil demand was recovering and it was possible to increase production, but the real problem was compensation from states that did not fulfil their obligations in May and June in entirety. “We can confidently say that we left behind the biggest difficulties associated with the falling demand. There are signs of recovery in demand, the number of flights, sales of motor fuel, while there is a likelihood of a second wave of the pandemic, which may entail risks for consumption,” Mr. Novak said.

The Russian minister believes that the launch of the second stage of adjustments (7.7 million barrels per day) is fully in line with current market trends. "This will make it possible to avoid volatility largely because the entire volume of produced oil will be consumed in domestic markets of producing countries as demand recovers," Mr. Novak added.

Meanwhile, the first stage of the deal goes on not smoothly as expected. In May-June, the market received about 1.5 million bpd, which was more than the specified volume.

According to the OPEC report, the member states should, in addition to their quotas, reduce production by another 1.3 million bpd in the future. Among the main violators of the deal are Iraq, Nigeria, Angola, Gabon, and Congo. Kazakhstan was publicly named as a violator among the non-member states of OPEC.

Nevertheless, the issue of softening the oil cuts beginning from August was settled. At the same time, the key aspect of the deal is its implementation by all signatories, including compliance with the compensation mechanism. Prince bin Salman calculated that, given the compensations for obligations that some signatories failed to fulfil, the volume of reduction in August will range from 8.1 to 8.3 million bpd, instead of the agreed 7.7.

Thus, in August, it is possible to compensate 400-640K bpd. Nigeria promised to follow the terms of the deal by 100% by the end of July, and Iraq - by the beginning of August. Angola, Gabon, Congo and South Sudan (not a member state) also reaffirmed their commitment to the deal and the intention to compensate for their failure to comply with the terms.

 

Compensation at own expense

According to ministers bin Salman and A. Novak, in addition to compensations, additional production volumes that appear during the transition to a softer version of the deal can be absorbed domestically due to the growing demand for fuel. In particular, in many OPEC+ countries, there is an increase in demand from energy companies, as well as an increase in the consumption of gasoline and diesel fuel as people begin to travel. Therefore, exports from OPEC+ countries will be limited and growth will hardly be felt.

“As we now move into the next phase of the deal, additional supplies that will emerge will be consumed as demand continues to grow. Economies around the world are opening up, although this is a careful and gradual process,” Mr. Abdulaziz bin Salman said.

In particular, he assured that Saudi Arabia will not export a single additionally produced barrel and plans to absorb all the incremental 500 thousand bpd domestically.

The head of the Saudi Arabian Ministry of Energy believes that Russia and other OPEC+ countries will also direct additional production volumes to domestic markets, as demand for gasoline grows.

Mr. Novak agreed with this statement without specifying the numbers. “We support that this reduction in quotas, which becomes effective in August, should not significantly affect the markets and increase exports, since August is a period of high demand for oil products, an increase in the number of trips, and the lifting of restrictive measures. All these factors should increase demand in domestic markets, including in the OPEC+ member-states,” Mr. Novak said.

He also noted that in Russia there is also a gradual recovery in the demand and consumption of oil products, which suggests that most of the growth in production will be used domestically.

 

Azeri Light on the rise

In general, the OPEC+ strategy has justified so far. "Thanks to this deal, we have achieved a two-fold increase in oil prices in the global market," Azerbaijani Energy Minister Parviz Shahbazov said.

Indeed, thanks to the updated OPEC+ deal, the price of Brent rose to $43 per barrel after falling to a 21-year low in April ($16). Moreover, the situation is progressing well for the local brand Azeri Light, which fell in April to a 19-year minimum ($15.81 per barrel). Since Azeri Light is traded at a premium in relation to Brent, its price on world markets at the moment varies within the range of $44-45 per barrel (CIF delivery terms).

By the way, for Azerbaijan, the price factor is of great importance, since oil is the country's main export product and, accordingly, the main source of foreign exchange earnings.

“Oil and gas production, oil prices on global markets are issues of particular importance to us. They are important not only for us, but also for all countries producing and exporting oil and gas, because the economies of these countries, already established economies, are built on these products. Therefore, the drop in oil prices by one dollar means the loss of millions of dollars,” President Ilham Aliyev said.

This means that Azerbaijan will support any efforts aimed at stabilising oil prices and will contribute to this process.

According to the head of the Azerbaijani Ministry of Energy, in the context of the ongoing pandemic and until the global economy recovers, OPEC+ remains the main instrument for regulating the balance in the oil market.

In May, daily oil production in Azerbaijan reached 557.2K bpd, which means that Azerbaijan fulfilled the terms of the OPEC+ deal by 98%, in June - 553.8K bpd (by 100.1%).

SOCAR, Azerbaijan International Operating Company (AIOC) - operator of the Azeri-Chirag-Guneshli block, as well as operating companies and joint ventures producing oil at onshore fields have been involved in the process of reducing oil production in Azerbaijan.

“Optimistic forecasts to cut oil supply from 100m barrels in 1Q2020 to 88.3m barrels in 3Q2020 suggest that OPEC+ supply regulation policy is justifying itself. According to forecasts, it is expected that the oil demand will exceed supply beginning in 3Q2020, and there will be a deficit of more than 3.9m barrels," Shahbazov said.

 

Pandemic against demand

Meanwhile, the increase in the number of cases globally raises concerns about the future demand for fuel and new oil surpluses. It is possible that a new wave of coronavirus in the US or in other key markets, such as India, China or South Korea, may worsen the situation again.

Rystad Energy analysts expect oil supply to remain higher than demand until the end of 2020 and believe that Brent crude prices should be capped close to $40 a barrel by the end of the year.

“While oil demand has boosted in recent weeks with the lifting of restrictive measures, easing production cuts may be premature given the state of the global economy and rising US coronavirus cases,” FXTM analyst Luqman Otunuga said.

Saudi Prince bin Salman also admits that there are risks of a second wave of the pandemic, but he is confident that in this case, OPEC+ ministers will be able to quickly gather and take appropriate measures in advance. "While lockdowns may emerge in some regions, there are clear signs of recovery in both the physical market and the futures market," he pointed out.

At the same time, Julius Baer analyst Norbert Rücker believes that "fears about a pandemic are unlikely to disrupt the movement towards normalisation, and not least because oil production will remain reduced for longer."

The oil market participants hope that the expected vaccine against COVID-19 helps improve the situation in the near future. “The recent positive news of progress in the development of the COVID-19 vaccine allow investors to focus on rebalancing in the long term,” AxiCorp analyst Stephen Inns said.

The positive news is reflected in oil prices as the vaccine will accelerate the economic recovery and boost oil demand. In the meantime, while developments go a long way of testing, OPEC+ always has the opportunity to return to tighter cuts so as not to lose the success it has achieved.



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