Saudis cut supply on weakening demand outlook

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OILUKMAR21 – Brent Crude Oil (March)
OILUSFEB21 – WTI Crude Oil (February)

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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