Record Oil Production Cuts to Save the Industry

Commodities Apr 15, 2020 / Reading Time: 2 mins
Aditya

Currently pursuing a Bachelors of Commerce at the University of New South Wales. Throughout his time in university, Aditya has immersed himself in a broad range of practical experiences in the investment management industry, from equities research at EverBlu Capital to short term interest rates trading at Commonweath Bank of Australia.



Record Oil Production Cuts to Save the Industry

The oil market began the week on an extremely positive note with OPEC/OPEC+ unanimously taking the initiative to cut oil production by 9.7 million barrels per day (bpd) on Sunday the 12th of April. This historic decision comes after the synergetic effects of coronavirus and the price war between the US, Saudi Arabia and Russia, which coerced nations to conclude that unprecedented measures must be taken during unprecedented times. The 23-nation group had the initial target to cut oil production by 10 million bpd, after facing slight resistance from Mexico, which was able to negotiate its cuts to 100,000 bpd from 400,000 bpd, the overall cut settled at 9.7 million bpd. This is equivalent to a cut of almost 10% of global supplied daily.

Effects on the crude oil market

The record US-backed OPEC deal provided an initial price rally just prior to the agreement but analysts claim that the cuts in place will not have the desired effect of propping up oil prices. The international benchmark, Brent crude, opened sharply higher after the long weekend break but prices soon reverted to approximately $32 per barrel. Similarly, West Texas Intermediate traded higher initially but reached lows of $22.03.

Is it enough?

The unsustained price increase brings about the question regarding the efficacy of the production cuts as the cuts may not be enough to avoid the global build-up of stock in the second quarter. Furthermore, analysts and traders also hypothesised that as the measures to halt the spread of the virus has caused significant impacts to growth, the fear of entering a deep recession will further decrease the demand in fuel and hence lower the price. In fact, global markets were unimpressed as the cuts will most likely not be enough to counter the 30% decline in demand as a result of factories closing, airlines substantially decreasing flights and the general population being urged to stay inside their homes. Also, the deal is structured in such a way that the 9.7 million bpd cuts will only last until the end of June when they will fall to 8 million bpd until the end of the year. This will further play into the volatility of oil prices as the uncertainty of the ramifications of the coronavirus will interplay with the structure of the OPEC deal.

Outlook on the oil market

Given the lack of positivity surrounding the deal, the outlook remains bleak around future oil prices as the cut in supply from OPEC and its allies will realistically fail to outweigh the negative impacts of an increase in oil storage. As such it is likely that Brent crude prices may fall back to the low-mid $20 per barrel range, which is a highly material change from the $70 per barrel at the start of the year.

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