PRICE INCREASE DROP BY DROP

The beginning of May has shown a gradual relief of the COVID-19 lockdown in a number of European countries. Along with the start of the new OPEC+ deal, this has a positive effect on the oil price. For the first time, the price of leading oil grades increased to a three-week low, reaching $31.7 per barrel for Brent and $25.7 per barrel for WTI.

Positive trend

"As more economies start to reopen, crude oil finds itself in the opposite situation of where it has been, as the forces which drive the price collapse - falling demand and a failure to cut production - start to reverse into a situation of potentially recovering demand and falling production”, Colin Cieszynski, Chief Market Strategist at SIA Wealth Management, said.

Oil prices were also supported by reports on the growth of Chinese oil imports in monthly terms and a slowdown in the filling of oil storage facilities.

Although market tension still persists due to the imbalance between supply and demand, analysts are optimistic about the further development of the situation, which also depends on the participants in the oil market. “Despite the growth of the volumes of oil and oil products remains a market risk, key trends both on supply and demand started to improve,” Robbie Fraser of Schneider Electric said.

“We observe a growing decline in oil production outside OPEC+. Despite the excess of oil supply on the market, we believe the situation can change quite quickly,” Helge Andre Martinsen, DNB analyst, said.

Analysts at Morgan Stanley believe that the peak of the oversupply has probably already passed, although it will continue to exceed demand in the next few weeks.

The real outcome of the OPEC+ deal agreed in May can be seen no earlier than the first decade of June. During May, oil prices may change under the influence of various factors, including but not limited to tensions between the US and China, the large concentration of unloaded tankers in American ports and the refusal of American oil companies to participate in the OPEC+ deal, and new negative forecasts of the International Energy Agency and OPEC on the global oil demand in 2020.

From words to deeds

The OPEC+ deal to reduce oil production to balance the market became effective on May 1. The agreement assumes a decrease in oil production by OPEC member and non-member states in May-June by almost 10 mbpd from the level of October 2018, with the exception of Russia and Saudi Arabia, which will decrease from 11 mbpd.

OPEC President, Algerian Minister of Energy Mohamed Arkab, on the very first day of the transaction urged OPEC+ countries to fully comply with the agreement to reduce oil production and confirmed Algeria’s readiness to cut production from May 1 in accordance with the agreement. “Given the unprecedented challenges on the oil market, it is imperative that all signatories fully comply with their obligations to voluntarily reduce production,”  Arkab said.

On May 7, Saudi Arabia announced that it would raise Arab Light oil prices for buyers from all regions in June, thus demonstrating that it was more interested in supporting the oil market than in building up its share. According to state-owned company Saudi Aramco, for Asian customers, Arab Light will rise in price by $1.4 per barrel. For buyers from northwestern Europe, prices will rise by $3.7 per barrel.

The US, Brazil and Canada are expected to decrease about 3.7 mbpd in line with the OPEC+ deal, as production in these countries is declining amid falling oil prices.

A number of US shale oil producers, including Diamondback Energy Inc., Parsley Energy Inc. and Centennial Resource Development Inc., already announced a forced reduction in production due to a sharp drop in oil prices.

However, the Texas Railroad Commission, the oil regulator of the main oil state of the United States, at a meeting on May 5, decided not to introduce a mandatory proportional reduction in production by state oil companies. Commissioner Ryan Sitton, who initially proposed such a reduction, expressed his concerns about the future of the Texas oil industry. In his opinion, the market will recover from the crisis caused by the coronavirus COVID-19 only after two or three years, and even then the demand for oil will be lower than in the pre-crisis period. Sitton believes that in the end, Texas will be just in the list of those who will never be able to return to the previous level of production.

Meanwhile, good news came from Norway. The largest oil producer in Western Europe decided to reduce oil production from June to December 2020, thereby joining the OPEC+ agreements. Norway is the last of the major oil producers to decide to reduce oil production.

According to the country's oil minister Tina Bru, oil production in Norway in June will decrease by 250K bpd and another 134K bpd in 2H2020. In addition, Norway will postpone the launch of some oil production projects until 2021. It is going to the first production cut for Norway in 18 years.

Russia is preparing to reduce

In Russia, one of the leaders of the OPEC+ deal, all Russian companies, including small companies and projects implemented under the Production Sharing Agreement, will join reduction trend too.

Russian Energy Minister Alexander Novak expects a decrease in oil production in other countries by 10 mbpd in May. “The economic situation at such low prices will lead to a reduction in oil production in other countries too. If the countries producing 46% of the global oil volume agreed to cut production by 10 mbpd, I’m sure that the rest of producers will have to cut the production by 10 mbpd due to the economic conjuncture and price reduction,” Novak said. Russian Ministry of Energy also sees signs of a recovery in oil demand due to weakening quarantine in a number of countries.

Meanwhile, Deputy Energy Minister of Russia, Pavel Sorokin, believes that not all countries will be able to fulfil commitments to reduce oil production by 100% due to the large presence in some of them of international companies with more than 50% of production. In his opinion, the excess of oil on the world market now reaches 10 mbpd, and a fall in commercial stocks with a normal recovery in demand and in the absence of shocks may begin in the third quarter of 2020.

By the way, market expectations of balancing oil supply and demand as a result of the OPEC+ agreements and the restoration of demand after lifting quarantine restrictions positively affected the cost of the Russian Urals mix, which returned to around $24-25 per barrel.

Azerbaijan: quotas distributed

Azerbaijani authorities announced the start of reduction within OPEC+ from the first day the transaction became effective. The country pledged to reduce oil production excluding condensate from the indicator of October 2018, i.e. from 718K bpd. With this in mind, in May-June of 2020, Azerbaijan should reduce oil production by 23% of the indicated figure, in July-December - by 18%, and from January 2021 to April 2022 - by 14%.

SOCAR, Azerbaijan International Operating Company (AIOC), joint ventures and operating companies developing onshore fields have been involved in the process of reducing oil production. “To fulfil the OPEC+ obligations, oil production in Azerbaijan in May-December 2020 will decrease by 17.4 million barrels to 141.8 million barrels. In 2021, oil production in Azerbaijan is projected at 30.7 million tons, or 226.3 million barrels,” SOCAR said.

It is interesting that in order to fulfil its obligations, SOCAR is considering the possibility of halting oil production in onshore fields with high prime costs. “Until the end of 2020, production association SOCAR Azneft plans to limit production on a number of oil and gas fields and to preserve equipment. At the same time, we study the issue of terminating the exploitation of mainly onshore fields with a high cost of oil production and continuing exploitation of a number of offshore fields with higher profitability,” SOCAR said.

So, the goals are known, the tasks are set, the ways to solve them are defined. If ultimately the OPEC+ countries, through collective reduction, provide serious support to the oil market, then these sacrifices will not be in vain.

“[OPEC+ deal] is the largest agreement in terms of the volumes of oil production to reduce in the history of the world oil industry. Azerbaijan expects that the fulfilment of these obligations will increase state revenues, as well as those of SOCAR and other oil producing companies in the country,” Energy Minister Perviz Shahbazov said.

Mr. Shahbazov believes that the solidarity at national and global levels to stabilize the oil market will gradually affect oil prices. “In 2Q2020, we expect oil demand to decrease by 15-25 mbpd, in 2020 - by 10.3 mbpd. In such a situation, the implementation of the OPEC+ deal by all the signatories, including Azerbaijan, will support the oil market,” Shahbazov said.

Hopes for growth

However, in the existing situation with the global spread of coronavirus and the risks associated with the second wave of disease, it is useless to count on a rapid increase in the cost of oil.

"We still hope that Brent can recover to $38-39 per barrel by the end of the year," experts at Commonwealth Bank of Australia say. Meanwhile, they note that a significant recovery in prices is likely to happen only in the middle of the year, since in the near future a significant excess of oil reserves will continue.

Standard Chartered experts expect the balance in the oil market to recover in July, after which demand will exceed supply by the end of the year.

“The combination of reduced production and optimism about demand supports oil prices right now,” Michael McCarthy of CMC Markets Asia Pacific said. Nevertheless, he is skeptic about the demand, as the risk remains that stocks will continue to grow.

“The trajectory of global oil demand is improving, and demand may exceed supply by early June,” Jeffrey Curry, commodity sector analyst at Goldman Sachs, said.

“The fundamental outlook has improved. However, given the risk that the forecast of the global economy will continue to deteriorate, it is too early to talk about recovery,” Ole Slot Hansen, Director of Strategy for Commodity Markets at Saxo Bank A/S, said.

According to the UBS forecast, the oil supply will noticeably decrease in 2H2020, and demand will begin to grow in May. “The surplus of global oil supply in the second quarter could reach about 10 mbpd, but energy demand should begin to grow in May as quarantine restrictions are lifted,” the bank’s analysts write.

In the second half of the year, UBS expects a noticeable reduction in oil supply amid falling oil production within OPEC+ and outside the cartel. In the third quarter, the market will come to a state of balance, and in the fourth there will be a shortage of oil at all, experts of the bank expect.

According to the UBS forecast, the price of Brent oil will rise to $43 per barrel by the end of this year and $55 per barrel by the end of June 2021. The bank’s forecast for WTI crude oil for the middle of next year is $52 per barrel.

Unprecedented in its volumes and terms, the OPEC transaction has just become effective. The real outcome of the deal will become clear over time. A couple of weeks is too short to assess the situation, but enough to understand that in parallel with lifting the quarantine and the resumption of activities, a reduction in oil production by the cartel and its partners can give a good effect. According to the Russian Ministry of Energy, the two-year term of the agreement indicates the seriousness of the intentions to take measures to restore the market situation, restore the balance of supply and demand. The main thing is that these intentions do not remain on paper, otherwise the oil market will need more than a couple of years to leave the ‘intensive care unit’.