This week OPEC ministers and allies gathered in Vienna to discuss a coordinated production cut agreement set to expire in March.
When news broke Dec 5 that the group (called OPEC+) had decided to deepen the cuts by 500,000 barrels per day (bpd), the outcome was both a surprise and expected at the same time.
Deeper cuts were certainly on the table. But the assumption was that choice would be accompanied by an extension, possibly to December 2020.
Instead, the deal struck Dec 5 does not include an extension. The deeper cuts will be effective for only the first three months of 2020, though an extension is still possible when OPEC+ meets March 5-6.
The official OPEC press statement Dec 6 said Saudi Arabia and several other producers would make additional voluntary cuts, raising the total adjustment to more than 2.1 million bpd.
Let’s focus on the decision to deepen the cuts. What prompted the group to conclude the status quo wasn’t good enough?
For one thing, oil fundamentals weren’t terribly bullish for much of 2019. A good example is crude inventories.
We examined Ursa crude inventory data and found the size of the cut (1.2 million bpd) wasn’t sufficient to tighten the oil market (See below).
That same feeling was articulated by Saudi Arabia before the meeting took place. Saudi sources reportedly pushed for deeper cuts, with an eye toward supporting oil prices at a delicate time.
On Dec 5, Aramco set the initial share price at 32 riyals ($8.53) in the state-owned oil giant. The sale will raise $25.6 billion and values Aramco at $1.7 trillion.
The other heavyweight, Russia, wouldn’t outright endorse an extension, but didn’t actively lobby against one and seemed more occupied with minor details.
No wonder then that the oil trading community was betting heavily in favor of an output cut extension.
Just before the Dec 5 meeting got underway, the likelihood of OPEC+ deciding to increase output stood at only 2%, according to a model calculated by CME Group using weekly crude options prices.
What else explained the near certainty?
Keep in mind the turnaround in oil prices over the last year.
When the OPEC+ cut agreement was sealed Dec 2018, oil prices had been falling for ten straight weeks, down almost 30%.
Brent prices kept tumbling, hitting a low of ~ $50/b around Christmas, but then staged a strong rebound through the first quarter of 2019.
Source: IntercontinentalExchange via MarketView
Even though Brent has come off its year-to-date high, prices have been stable in a range of $60-$65/b for the second half of this year.
Producers and consumers love stability in the oil market, especially when prices find the “sweet spot” that is neither too high or too low.
That’s (arguably) where we find ourselves now. Are the cuts responsible?
One non-oil factor that helped was financial markets. Remember the plunge in the stock market in Q4 2018? Equities then staged a turnaround of their own, lifting a dark cloud hanging over other asset classes, including commodities.
Source: S&P Dow Jones Indices via MarketView
That said, the OPEC cuts did help remove supply from the market, as members mostly complied with the terms of the agreement.
The graph below shows average monthly production by the 11 OPEC members with mandatory quotas. Venezuela, Libya and Iran are exempt.
Since March, the total output has been well-below the collective allocation, according to the data, which comes from the monthly OPEC survey by S&P Global Platts.
Source: S&P Global Platts
But was it enough? Were the supply cuts deep enough to offset booming shale supply and sluggish demand?
The best indicator for supply-demand balance is inventories. However, data on global inventories is a patchwork of public sources providing information on a delayed basis and often seen as unreliable (the US Energy Information Administration is an exception).
Ursa fills this void by leveraging radar satellite imagery to measure crude inventories around the world every week.
The graph below shows global crude inventories in 2019 vs. 2018. Is there much evidence to support the argument the OPEC+ cuts have been working?
Global crude inventories in 2019 exceeded 2018 by a healthy margin during the summer.
Granted, the year-on-year (YoY) surplus would’ve been even larger without the OPEC+ cuts. Still, that’s not exactly a sign of a tightening oil market.
The story changes once autumn begins. But interestingly, the switch from YoY surplus to YoY deficit coincides with the Sept 14 attack on Saudi Arabia’s oil infrastructure.
The YoY deficit has remained in place since then, even though the disruption to Saudi production was short-lived.
The map below shows different regions and whether inventories in Nov 2019 were higher (black circle) or lower (red circle) than Nov 2018. The size of the circle is proportional to the absolute change.
Almost all regions have seen YoY inventory draws. A notable exception has been China where inventories in Nov 2019 were higher than Nov 2018.
However, that doesn’t tell the whole story. The last 12 months in China can be divided into two parts. The first half was defined by builds, the second half by draws.
With crude prices diving in late 2018, China went on a buying binge causing inventories to swell.
Crude imports have remained high, reaching record levels as recently as October, yet inventories haven’t surged on account of strong refinery demand.
It won’t be much longer until the YoY surplus is erased if current trends hold.
Another thing to consider is the size of China’s YoY surplus isn’t terribly large on a percentage basis.
The map below is identical to the one above, but expressed in percentage terms, instead of absolute value (barrels).
While China’s draw is smaller, on a percentage basis, the opposite is true in the Caribbean, a region badly hurt by Venezuela’s slow collapse.
What do you think? Will deeper supply cuts in 2020 result in higher oil prices?
Please stay tuned. And for a free evaluation of our data, click here.