OPEC and OPEC+ has reached record production cut agreement of almost 10 per cent in the pre-crisis level which took the production cut to 9.7 million barrels per day. The production cut would kick-in in May and June, post which it would shrink further to 7.7 million barrels per day for the remaining part 2020, and then to 5.8 million barrels per day from January 2020 to April 2021.
However, despite a large reduction in the global oil supply chain, crude oil prices are still extending the decline with prices of Brent crude oil futures (CFD) falling from a pre-meeting high of USD 36.40 (intraday high on 9 April 2020) to the present low of USD 27.16 (intraday low on 15 April 2020), down by ~ 25 per cent.
The investing community is now raising eyebrows over the price reactions, despite a production cut. However, investors should see the production cut through the lens of economic slowdown and estimations of various independent forecasters over the global economic condition, post the ongoing market turmoil.
In the status quo, the United States Energy Information Administration estimates that the average oil price would come lower in 2020 while sliding further ahead; however, the department utilised one strong assumption that the OPEC and OPEC+ would not risk the market share further and would not sit on the negotiation table to bring in any production cut.
Whilst one strong assumption of EIAs forecast went opposite, the overall forecast seems to be working just fine in the wake of fears over global economic growth ahead.
International Monetary Fund Forecast on Global Economy
While supply chain is one side of the price equation, in the status quo, demand factors hold higher weightage in shifting the price curve for commodities, especially crude oil, which is facing a server impact of the current travel restriction imposed by many Federal and State Governments worldwide.
IMF further cleared the dust around the global economic growth with numbers and suggested that the global economy could contract by 3 per cent in 2020, which is far worse than the contraction faced by the globe during the 2008-09 financial crisis: and,
- Under a base case scenario, which assumes that the COVID-19 pandemic would fade in the second half of the year 2020, IMF anticipates a 3 per cent contraction across the global economy; however, anticipates an expansion of 5.8 per cent in 2021.
On the advanced economies front, IMF anticipates that Italy, Spain, and Euro Zone would be among the hardest hit with an economic contraction of 9.1 per cent, 8.0 per cent, and 7.5 per cent, respectively in 2020, while nations like the United States, United Kingdom, and Japan are anticipated to mark a contraction of 6.1 per cent, 6.5 per cent, and 5.2 per cent, respectively.
What Could Support Crude Ahead?
While production cut of 10 per cent in the pre-crisis demand is one factor, which could work in favour of oil prices, these unprecedented times are hard to predict any growth or degeneration as factors which relatively contributes toward the economic growth are interacting in ways, which make it hard to pull them together under one roof.
However, IMF anticipates that now effective policies are essential to forestall the worse, and necessary measures to reduce contagion and protecting lives will take a short-term toll on economic activity but should also be seen as an important investment in long-term human and economic health.
The same could be said for the oil market, while it is hard to guess any trend for oil due to lesser economic interaction, the short-term measures adopted by the OPEC and Russia could be seen as the one with long-term implications.
Well, it’s a record production cut, isn’t it?
- Demand, the Ultimate Leader of Oil Price Ahead
While the production cut of nearly 10.0 million barrels per day is good, investors should also keep in mind that the global oil demand has taken a hit of nearly 30.0 million barrels per day from the pre-crisis level. The 20 million barrels of faded demand would be hard to restore over the short-run; however, the right policies and level of economic interaction would now decide the fate of oil market ahead and should be monitored closely.
A Glimpse on Future Market and It’s Mood
LCO Futures Curve (Source: Thomson Reuters)
On observing the forward curve of the Brent crude oil futures, it could be seen that the market is now turning slightly optimistic over the crude oil as the forward curve is sloping upwards, suggesting the convenience yield is increasing slowly as compared to the storage cost.
On further analysing the spread between the short-dated futures contract with the long-dated futures contract it could be seen that the long-term contracts are exchanging hands at a higher rate with consistency, i.e., the longer the maturity, the higher the price as compared to the short-term contract.
LCO Short and long-dated Maturities (Source: Thomson Reuters)
Currently, the Brent crude oil futures of December 2020 expiry is trading at a premium to all its short-term maturities, suggesting that the convenience yield could restore ahead. Also, the spread between the successive premiums is large, as compared to the onset of January 2020, reflecting that the market is slightly bullish over the long-term.
To Know How Crude Oil is Placed on Charts, Do Read: Crude Responds Intensely to Trump’s Tweet, Downtrend to Linger Ahead?
While the oil market is seeing its peaks and troughs, the gold is emerging in the limelight as the market turmoil grows stronger day-by-day. In the status quo, gold prices have breached the seven-year high, and many investment banks anticipate much higher value for gold ahead. For example, Goldman Sachs anticipated that gold could touch USD 1,800 over the next 12 months.
To Know More, Do Read: Gold Shatters 7-Year High, Joy Ride Coming For ASX-listed Gold Stocks?
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