After breaking the $50 barrier last year, oil prices are currently trading above $60. The major drivers behind this rally include the rise in vaccination rates and the 1 million bpd new year surprise cut from Saudi Arabia, in addition to continued high compliance from OPEC+.
Other factors include a slowdown in US oil production, with the number of oil rigs in the US remaining at least 50% below its 2019 levels at 309 rigs, indicating a potential flat production for 2021.
The current strategy of the US shale industry is to focus on stable returns to shareholders rather than supply growth which reduces the likelihood of production increases despite increasing prices. Since the Biden administration took office this year, we have seen major decisions supporting the climate agenda including the suspension of fracking on US Federal lands, the cancellation of the Keystone XL pipeline between Canada and the US, and the full return of the US to the Paris climate agreement.
Such policies have raised questions about ensuring sufficient investment in new oil production and raises concerns about the security of supply in the next few years as the world recovers from the COVID-19 pandemic. Prices of copper for instance rose by 10.6% since President Biden took office which gives a clear indication of rising demand for this metal to achieve energy transition targets.
Furthermore, the Texas freeze added to the list of bullish factors, as almost 4 million bpd of crude oil output came offline, marking the worst energy crisis in the history of the state. The US dollar index is also at record lows, mainly due to rising inflation prospects, and bond yields which reduce the appetite for investors in investing in bonds and shift investors’ interests in physical assets like commodities.
Many investment banks have recently warned against an oil price supercycle in 2021, yet as OPEC+ continues to hold around 7 million bpd off the markets, we think it is still early to predict such supercycles.
Will OPEC+ ease production cuts?
OPEC+ is meeting this week to decide on the production policy beyond March. While the most likely scenario is that the group will ease production cuts, it remains highly uncertain how many additional barrels the group will push onto the markets. Another key question is whether Saudi Arabia will decide to extend its voluntary cuts beyond March. Last December, the group had agreed on adding 500,000 bpd starting from January to meet an original plan of 2 million extra supplies bpd by April. Yet, the group had postponed adding another 500,000 bpd in February and only Russia and Kazakhstan were allowed to raise production (75,000 bpd each), leading the group’s total easing to 650,000 bpd since December last year. Saudi Arabia also added additional voluntary cuts of 1 million bpd for February and March which provided strong support to the current price rally. Under the current conditions, it remains highly questionable whether OPEC+ will decide to raise production by 1.35 million bpd of the original 2 million bpd to be extra supplied in April.
During a speech at the International Energy Forum, the Saudi Energy Minister has indicated that producers should remain cautious and vigilant of market changes. Furthermore, the UAE Energy Minister has indicated in a statement that the amount to be released by the group will hinge on the pace of global vaccination campaigns, calling for increasing production in a phased manner. Even if OPEC+ agrees on the 1.35 million bpd production hike, the market would be willing to see what policy will Saudi Arabia follow regarding its current voluntary cuts beyond March.
From the Russian side, we expect Russia to be pushing for a 1.35 million bpd production hike as per the original agreement. The Russian Deputy Prime Minister Alexander Novak has indicated on several occasions that oil markets are currently in balance implying producers should return supply that’s currently being held off the markets.
The Saudi Energy Minister has also indicated that these extra cuts are for two months, February and March. It is uncertain if Saudi Arabia will remove these cuts fully or gradually. If Saudi Arabia ceases its voluntary cuts, its production would be around 9.49 million bpd in April, from 8.11 million bpd in March.
One scenario is that the group may decide to bring 1.35 million bpd back into the markets by April bringing total cuts down to around 5.8 million bpd. Under this scenario, we expect prices to retreat below the $60 level, a scenario that the Russians may advocate. Another scenario is that the group may decide to ease cuts gradually by less than 1.35 million bpd with gradual ease of Saudi cuts. Under this scenario, we expect prices to stay within the $60-$65 range.
US Stocks and Demand levels may support an OPEC+ decision to hike production
Meanwhile, US oil inventories stand at 463 million barrels, only 19.7 million barrels above their level before the pandemic, while US oil production is at 9.7 million bpd facing a large decline due to the oil freeze seen in Texas. US oil demand is almost back to pre-crisis levels, as seen by the recorded demand for petroleum products at 18.69 million bpd, 1.18 million bpd below their levels a year ago. The majority of the decline continues to be in gasoline stocks, which stand at 7.21 million bpd, down by 1.2 million bpd y/y. It is worth mentioning that the Texas freeze has also contributed to a decline in demand for petroleum products which were seen at 20.67 million bpd a week ago, above its pre-crisis levels. This is also indicated by the level of refining runs which stood at 12.23 million bpd, down by 2.59 million bpd w/w, compared with 14.82 million bpd reported a week ago. The loss in refining runs resulted from shutting down many refineries on the U.S. Gulf Coast. These numbers may provide yet another incentive for OPEC+ to ease output cuts.