The agreement by OPEC+, led by Russia and Saudi Arabia, to reduce oil production and bring about voluntary market-driven reductions by other G20 producers is unlikely to significantly boost oil prices in the near term. But better late than never even though the deal does not fix the global oil demand collapse. The combined OPEC+ and G-20 cuts should set in place a bottoming process for oil prices and significantly limit the tail risk of free-falling into the single digits in our view.
The deal facilitated by President Trump and agreed on by Saudi Arabia and Russia, the two biggest producers in the deal, targets to cut about 6.5m b/d between them. The 9.7m b/d of combined OPEC+ cuts will apply from May to June after which it tapers off. The curbs would decline to 8m b/d until the end of the year and to 6m b/d between January 2021 and April 2022, but the need for this last phase is to be assessed by December 2020. Despite an initial standoff between Saudi Arabia and Mexico, Mexico was eventually awarded a concession to cut by a smaller margin than its OPEC+ peers.
OPEC+ officials are reportedly hopeful the US, Brazil, Norway and Canada could collectively contribute a 3.7 m b/d output reduction, which is more likely to be market-driven.
Trump’s more active role in oil diplomacy is likely in response to lobbying pressure from US shale producers. The OPEC+ deal should satisfy each side of a divided US oil industry. On the one hand, struggling smaller US shale producers are advocating for state actions, including imposing tariffs on US oil imports. On the other hand, the big US oil companies, likely viewing smaller shale companies as potential targets, had lobbied to let free markets rule, whatever the price impact.
What is still likely are price-induced cutbacks of US oil production. ExxonMobil announced a 30% cut to capital spending, with most of it coming from the Permian Basin. If mirrored across the shale industry, output will fall quickly. However, hedges and facilities and equipment contracts already in place could shield US oil production in the short term although a more material cutback is likely by July.
US oil supply to respond to lower oil prices
Source: Bloomberg, Bank of Singapore
A fading of the Covid-19 shock to oil demand and US oil supply cutbacks should allow Brent to rebound to USD45/bbl in a year’s time.
Containment measures in the US and Europe are seemingly taking effect in flattening the Covid-19 infection curve, which in turn has encouraged discussion of reversal of economic lockdowns. In the meantime, the Fed’s expansion of the size and scope of its corporate bonds buying program (or QE infinity on steroids) has reinforced the view that central banks and fiscal measures will bridge the gap between an economic winter and the eventual arrival of spring for companies and households.
Reduced tail risk of an oil price free fall is a modest relief for petro-currencies such as CAD, NOK and RUB. The MXN, which is deeply undervalued after the recent sell-off and sensitive to oil price changes, should also benefit.
FX purchases by the Norges Bank should continue to be supportive of the NOK. Unlike most peers, higher government spending in Norway will largely be financed by the oil fund, rather than increased borrowing. Norges Bank announced it will buy NOK2bn a day on behalf of the government in April, further ramping up the pace of its FX purchases from the NOK1.6bn a day announced on 18 March.Disclaimer applicable to recommendation
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