Opec+ extension to tighten markets with oil trading above $40, analysts say

Opec's core Gulf members are unlikely to make additional voluntary cuts as they press laggards into full compliance

The Opec+ production cut deal helped draw down inventory levels and returned oil prices to above $40 per barrel. Reuters

The extension of a oil production cut pact by Opec+ is expected to tighten markets in the foreseeable future as countries ease lockdown measures and demand picks up.

The alliance, a group of 23 oil-producing countries that includes Russia, formally agreed to extend cuts for May and June amounting to 9.7 million barrels per day to the end of July.

The Joint Technical Committee, which reviews market conditions on behalf of the Opec+ alliance, will meet on June 17 while the Joint Ministerial Monitoring Committee, which monitors the compliance and production quotas of Opec+ members, will meet a day later.

The JMMC will meet once a month until December to monitor compliance.

Tapered cuts are in place until 2022. Opec+ also came down hard on countries that have repeatedly failed to meet their quota of cuts, notably Iraq and Nigeria, and pressed them to compensate by introducing additional curbs until September.

“The 9.7 million bpd production cuts were already working; extending them [by] an extra month will tighten [the] market more quickly,” said Ann-Louise Hittle, vice president for macro oils at Wood Mackenzie.

The consultancy expects Brent, the international crude benchmark, to recover to between $45 and $50 a barrel from the current level of $40.

Supply and demand are expected to balance in the third quarter, Ms Hittle said. Global oil demand is set to exceed supply and cause oil prices to increase, she said.

“This trend does not depend on full adherence from all members of the Opec+ group as we assume about 70 per cent compliance on average, with some at higher rates than others,” Ms Hittle said.

Before Saturday's meeting, West African producer Nigeria offered to comply fully and cut back.

Saudi Arabia’s energy minister Prince Abdulaziz bin Salman called for greater compliance among members and highlighted the “sacrifices” made by the kingdom and key Gulf members in cutting more than they were required to.

Ali Malik, a senior investment adviser at the Bank of Singapore, said the worst appeared to be over for oil markets as Opec+ adopts a “stricter approach” towards members such as Iraq and Nigeria.

The bank maintained its 12-month forecast for Brent at $45 per barrel, but has raised its three-month forecast from $30 to $36 and its six-month forecast from $38 to $40.

Brent settled at a three-month high of $42.30 on Friday before the meeting, while West Texas Intermediate, the key US gauge, closed at $39.55 per barrel.

WTI has recovered steadily from a bleak April when prices fell to -$40 per barrel. The tightening of spreads between Brent and WTI signalled “a broader rebalancing of the US oil market”, Mr Malik said.

“Assuming average prices continue to edge up in the second half of 2020, questions will grow as to whether and how quickly shut-in US production will be turned back on,” he said.

The US energy industry has been devastated by the collapse in prices resulting from the economic fallout caused by the coronavirus pandemic.

Prices fell by about 70 per cent in April from peaks in January. US production collapsed rapidly and the number of active oil rigs fell to 222 - the lowest since 2009.

“A strong and immediate comeback in US shale is going to be a very dim possibility for now,” said Vijay Valecha, chief investment officer at Century Financial in Dubai.

The US oil benchmark needs to rally from its current levels to the pre-pandemic range of $50 per barrel “to bring back animal spirits in the US shale oil industry,” he said.

A price range of $50 to $60 is needed for many US shale producers to break even.

Meanwhile, the Opec+ communique did not mention whether Saudi Arabia, the UAE and Kuwait would continue to volunteer to cut further than they were required to.

Riyadh pledged an additional cut of one million bpd in June, bringing its total output curbs to 4.8 million bpd. Kuwait and the UAE also offered to cut back an additional 80,000 bpd and 100,000 bpd, respectively.

“Going ahead, should the oil prices hold and even rally above the current levels, it is highly unlikely for these producers to announce further additional cuts,” Mr Valecha said.

He said “the economic cost of announcing additional cuts” far outweighs the short-term rewards.

Century Financial expects both crude benchmarks to retest their March levels, with WTI trending between $42 and $44 per barrel, while Brent is expected to average between $46 and $48 per barrel.