Saudis cut supply on weakening demand outlook
Head of Commodity Strategy
Summary: Following a bumpy start to 2021 crude oil jumped higher after Saudi Arabia, increasingly viewed as the guardian of oil markets, unilaterally decided to cut production in February and March. While the price from a producer perspective received a welcome boost, the reasons behind the decision is probably driven by a growing concern about the near term outlook for demand. A renewed surge in corona virus cases, now also in Asia, has once again left the prevailing outlook challenged and with this in mind the cut not only looked well timed but also needed in order to prevent another setback
What is our trading focus?
OILUKMAR21 – Brent Crude Oil (March)
OILUSFEB21 – WTI Crude Oil (February)
Three days into the new year and the crude oil market has already seen its fair share of drama. After racing out of the gates on Monday to hit a fresh ten-month high on continued vaccine-optimism, it made a sudden about turn in response to what increasingly looks like a grim period ahead. Extended lockdowns and with that reduced mobility across the world is the current response to the fast mutating virus variant first seen in UK.
Into this uncertain outlook OPEC+ met in order to determine whether the market needed additional barrels on top of the 500,000 barrels/day agreed for January. A stubborn stance from Russia, who was looking for another increase, spooked the market and WTI and Brent both sold off before yesterday’s surprise outcome.
In the end, the group agreed on the most sensible outcome, i.e. to rollover current production levels to March. Topping up the agreement was the surprise unilateral production cut announced by Saudi Arabia, which increasingly is being seen as the guardian of the oil market. Setting worries aside the risk of yielding market share to others, especially US shale oil producers, the Saudis most likely concluded that the next few months could see weakness in Western world fuel demand spread to Asia where infections are rising quickly.
Following the initial price jump we believe the market will conclude that at best this decision would help stabilize the price of oil and not sending it higher at this stage. On that basis we maintain the view that while crude oil prices will eventually move higher, this is not the time, given the elevated level of uncertainty with regards to demand.
Crude oil has rallied hard since the early November vaccine news and while the weaker dollar and increased demand for reflation hedges have played its part, the ultimate driver for further price gains will be a pickup in global fuel demand. Something that we are unlikely to see until the vaccine rollout reach a level of penetration that can support renewed mobility and travel activity.
Following the US election win for Biden in November and the prospect for the democrats winning a paper thin senate majority, the focus on reflation hedges have supported a general appetite for commodities. At the end of 2020, speculators held a record 2.5 million lots long across 25 major commodity futures, representing a nominal value of $125 billion. While the two previous peaks in 2017 and 2018 were primarily led by the crude oil market, the chart below shows how bullish bets have been spread out more evenly between the three major sectors of energy, metals and agriculture.
While the biggest of these bets are held in crude oil with the combined 614k lots long in WTI and Brent representing a nominal value of $30 billion, it is worth keeping in mind that the net long remains well below the 1.1 million lots record from March 2018.
Buyers may attempt to drive Brent crude oil towards $55/b, the bottom of the 2019 consolidation range, but with the clouded demand outlook is unlikely to push it higher than that with support currently at $49/b followed by $46.60/b
Later today at 15:30 GMT, the US Energy Information Administration will release its “Weekly Petroleum Status Report”. The American Petroleum Institute reported late Tuesday that US crude oil stocks fell by 1.7 million barrels in the week to January 1. The data also showed a major gain in product stocks with gasoline and distillates rising a combined 12.6 million barrels. While the market impact given the period covered is likely to be limited, some focus will still be on implied demand for products in order to gauge the virus impact on consumers.
As per usual I will post the result on my Twitter handle @ole_s_hansen
Latest Market Insights
Q4 Outlook 2022: Winter is coming
- Winter is coming to the financial markets as central banks are tightening their grip. How spring will look is still a question.
European energy crisis: it will get worse before it gets betterThe winter in Europe will be tough, but whether the result is political chaos or sustainable, innovative solutions is still undecided.
A difficult and volatile quarter awaitsAs the year draws to an end, commodities continue to be at centre stage of the world with growth pockets political uncertainty.
The bright side: crises drive innovationThe positive spin on crises is that they come with solutions. It is worrisome that deglobalisation may be a response to this crisis.
Green transformation in China: renewable energy and beyondGoing green, China needs to span numerous energy sources to ensure stability, as every source comes with a challenge.
Asia: Intermittent solutions, but a faster renewable adoption curveAsian energy supply is being squeezed. This and the adoption of renewables may change the investment sentiment in the region.
FX: A Fed thaw needed to deliver a sustained USD turn lowerThe US Dollar can keep momentum when the Federal Reserve continues to tighten, leaving the rest to play to their drum.
Autumn can become ugly for equities and bond holders. Comfort for Dollar longsTechnical analysis suggests that equities could face a tough Q4 as could fixed income. US Dollar positions could provide some upside.
The next stock market sector to watch, with stocks going nuclearAs the world scrambles to find affordable, sustainable energy, nuclear is getting attention from politicians and investors alike.
The crypto space is getting cold when the hype disappearsCryptocurrencies face a winter of their own as retail investors and governments are asking tough questions.