28 October – OPEC+ set for a three-month output rollover

Saudi Arabia and Russia will probably agree to extend their oil production cuts and postpone planned increases when they meet for talks with their OPEC+ partners at the end of November.

For tactical reasons, both countries are trying to avoid committing to a rollover until the meeting is closer, seeking to keep their options open and secure adherence from other oil producers in the OPEC+ group.

At present, the production schedule agreed by OPEC+ in April implies the group’s output will increase by almost 2 million barrels per day (bpd) from the start of January.

But global inventories remain well above their five-year average, consumption has recovered more slowly than expected and a resurgent COVID-19 pandemic threatens a double-dip recession and another hit to oil demand.

There is no indication the market needs an extra 2 million bpd in the near future or would be able to absorb the extra crude without raising inventories and causing prices to fall.

And the first quarter traditionally has the weakest crude demand from refiners, so adding extra barrels at this point in the year would be especially risky for oil producers.

Saudi Arabia and Russia, the key decision-makers in OPEC+, are therefore likely to postpone the output increase, probably for three months until April, with a review in March.

The alternatives would be a shorter two-month postponement or a smaller output increase from the start of the year – limited to 1 million bpd or less – with further increases subject to a review in March.

More aggressively, OPEC+ could commit to postpone output increases for six months until July, pending a review in June, which might fan bullish sentiment but reduce the group’s flexibility and strain its internal cohesion.

None of these alternatives is clearly superior to a three-month postponement, which is therefore the most likely outcome from the meetings over Nov. 30 and Dec. 1.

OFFICIAL COMMENTARY
Recent comments from OPEC’s secretary-general and Russia’s president have acknowledged that consumption remains lower than expected and signalled openness to a postponement.

“We were hopeful the second half of 2020 would begin to see a recovery,” OPEC’s Mohammad Barkindo said on Monday (“OPEC chief says rising infections may delay oil recovery”, Reuters, Oct. 27).

“Unfortunately, both the economic growth and demand recovery remain anaemic at the moment due largely to the virus.”Barkindo’s comments build on a similarly careful signal from Russia last week.

“We believe there is no need to change anything in our agreements; we will closely watch how the market is recovering. Consumption is on the rise,” Russian President Vladimir Putin said last week.

“However, we do not rule out that we could keep existing restrictions on production, and not remove them as quickly as we had planned to do earlier,” Putin added (“Russia’s Putin- rollover on oil output curbs possible”, Reuters, Oct. 22).

WELL-SUPPLIED MARKET
In the United States, high-frequency data shows stocks of crude and products outside the strategic petroleum reserve are still 113 million barrels, or nearly 9%, above the five-year seasonal average.

Excess inventories have fallen from 180 million barrels (14%) at the start of July but at their current rate of decline would still be above the five-year average at the end of March.Crude traders and investors are not forecasting any shortage of oil in the foreseeable future that would prompt OPEC+ to increase production.

The five-week calendar spread for dated Brent is currently trading in a contango of 70 cents a barrel, which is in the 16th percentile for all trading days since 2010, indicating physical crude supplies remain plentiful.

The six-month calendar spread for Brent futures is currently in a contango of $1.90, which is in the 24th percentile for all trading days since 1990, again indicating that the market is expected to remain well-supplied.

The contango in both physical and futures markets is wider than in February-March, when Saudi Arabia resisted pressure from Russia to increase output, so it is hard to see why the kingdom would now want to raise output aggressively.Crude production and exports from Libya have already started to rise, which will add barrels to the market even if OPEC+ decides to roll over current output levels.

Physical traders and portfolio managers have started to price in a high probability of a rollover in recent weeks, which has helped to support spot prices and calendar spreads despite the worsening epidemic.

If OPEC+ were to disappoint those expectations, it would risk a sharp short-term decline in prices and spreads as positions accumulated since the start of October are unwound.

For all these reasons, OPEC+ is likely to roll over its current production levels with few, if any, changes. And most likely for three months with another review towards the end of the first quarter.