Opec Output Cuts Keep Oil Firm, Trade Deal To Add Fuel To The Rally

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US

crude oil

rallied this month to post its best January performance on record, breaking a three-month losing streak that saw futures lose nearly half of their value. The energy complex has been boosted by Opec-led production cuts aimed at draining oversupply and US sanctions on

Venezuela

, which threaten to disrupt global trade flows and bolster prices.

On the other hand, prices got pressurised after weak data from China amid an ongoing trade dispute with Washington. Additionally, a slowing global economy hurt crude as IMF lowered its 2019 growth forecast from 3.7 per cent to 3.5 per cent. Business sentiment is buckling under pressure from the deteriorating relationship between the United States and China as well as tightening financial conditions in the form of higher borrowing costs and falling equity prices.

US production

In the US, crude production climbed by 2,00,000 barrels a day last week to 11.9 million, the highest level since 1983. Furthermore, the Department of Energy forecast that US oil production will jump from 10.9 million barrels per day in 2018 to 12.9 million bpd in 2020. Additionally, the US is also expected to start exporting more crude oil and fuel than it imports in 2020.

According to IEA forecast, production in the US will rise by 1.3 million bpd this year. That’s slower than the record 2.1 million increase in 2018.

On the monthly report, IEA said global oil demand remains on course to be stronger this year than in 2018 as a boost from lower fuel prices counters slowing economic activity. IEA's estimate is oil consumption will expand by 1.4 million bpd, about 1.4 per cent, in 2019, slightly higher than last year’s expansion of 1.3 million.

The OPEC monthly report showed that production from Opec’s 14 members sank by 751,000 barrels a day last month, with just over half the reduction coming from Saudi Arabia. It’s the biggest cut since the bloc kicked off a previous round of curbs in early 2017.

Venezuela crisis

Crude is also drawing support from new US sanctions against Venezuela’s state-owned oil firm

PDVSA

. About half of Venezuela’s roughly 1 million barrels per day in exports go to US refineries. The sanctions are forcing Venezuela to find new off takers, primarily in India and China, and prompting American refiners to substitute the barrels.

It exported about 5,00,000 barrels of heavy crude a day to the US, but that has now fallen to about 3,50,000 barrels a day. This is raising concerns that we could see some cut in US runs because those barrels won't be easily replaced and could cause future diesel shortages. US refineries that depend on Venezuela’s heavy crude would have even more trouble securing supplies as Canadian and Mexican crudes are often not as discounted and are limited in availability.

China factor

Crude prices saw some support after markets turned optimistic over the high level trade talks between the US and China. Meanwhile, the slowdown in China has led to worries of global slowdown. We saw prices remaining firm after data from China showed that China’s economy grew by 6.6 per cent in 2018, its slowest expansion in 28 years and down from a revised 6.8 per cent in 2017.

China’s September-December 2018 growth was at 6.4 per cent, down from 6.5 per cent in the previous quarter. Although the slowdown was in line with expectations, the cooling of the world’s number two economy casts a shadow over global growth. The global economic expansion has been losing momentum since the middle of last year, and there are signs the slowdown has worsened in recent months, with risks skewed to the downside.

So, oil consumption, especially middle distillates such as diesel, which are closely linked to freight transportation and industrial activity, is likely to grow more slowly in 2019.

OPEC cuts

Saudi Arabia has made an early start on production cuts, unplanned losses have steadied in fellow members Iran and Venezuela. At the same time, Saudi shipments to the US have been falling as OPEC and 10 other nations including Russia aim to keep 1.2 million bpd off the market.

Saudi Energy Minister Khalid al-Falih said the kingdom will target output at 10.1 million bpd, down from its January goal and below its quota under the so-called OPEC+ deal. Prices were supported after the estimation of OPEC based supply cuts to bring balance in the markets. The data showed OPEC pumped 30.98 million barrels per day in January, down 890,000 bpd from December.

A breakout through $55 in WTI and $65 in Brent would be a very bullish signal for these and could be the catalyst for more significant upside. Overall, output cuts planned by Opec and its partners should stabilise world markets though the process will be slow.

To fully implement its agreed cutbacks, Opec would need to cut by a significant 9,00,000 barrels a day this month, with its allies reducing by a further 3,70,000. If the global economy falls into an extended soft patch or even a recession, Opec and its allies will probably have to make further cuts to prevent a surplus re-emerging.

Likewise, if US shale production does not slow as quickly as anticipated, OPEC+ will come under pressure to cut output further. On the other hand, if the economy grows strongly, and/or shale production slows sharply, the resulting market tightening will encourage OPEC+ to unwind some of its output restraints.

The rally will move with greater upside momentum if there is a major catalyst like a news event. However, buyers are likely to remain cautious until they are confident that the US and China can come to terms over a new trade agreement.

There is a March 1 deadline for an agreement, but both parties could extend this deadline if progress is being made. This could be a positive development, along with an actual deal that spikes prices to the upside.