Wednesday, April 8, 2020

With crude oil futures in a super-contango, will there be a historical production cut this week?

  • Oil
  • Brent


Analysts’ Pick: With crude oil futures in a super-contango, will there be a historical production cut this week?

  • Incentives for oil-producing countries are likely aligned for a production cut in the short-term
  • Demand however, is still likely to be heavily impacted in the medium-term by lockdown measures applied by major countries to combat the coronavirus outbreak
  • Our outlook for oil prices is skewed to the upside in the short-term but subdued in the medium-term

Since signals from Russia and Saudi Arabia signalled that both countries were willing to discuss oil production cuts, oil futures have skyrocketed, with Brent rising to as high as US$34.11 per barrel last Friday. US President Donald Trump's tweet also helped gains in energy markets after tweeting that production cuts could be as much as 15mn barrels per day.

Oil prices continue to trade at low levels despite last week’s 37.87% gain


With Riyadh also hosting a virtual meeting with G20 energy ministers on Friday, investors likely are pricing in the possibility of officials from the Kingdom calling on production cuts from other non-OPEC oil producing countries such as the US, Canada and Norway as well. Reports that oil traders are stockpiling oil supply on oil tankers docked in the ocean to generate high amounts of profits in a short amount of time supports this as well.

Brent Crude oil futures shifted into a deep contango last week, although has eased slightly today


Last week’s spread between one-month and six-month Brent crude oil futures reached a record high


The Energy Information Administration (EIA) in the US revised its forecast for oil production in 2020 for the US, cutting roughly one million barrels per day from its previous forecast to 11.8mn barrels per day for 2020. The EIA's report also highlights a significant reduction in demand for liquid fuels during the first half of 2020 thank to the Covid-19 virus outbreak, with the largest impact in the second quarter of 2020. This implies that US production will probably be cut whether by government intervention or as an indirect impact of reduced demand as only a handful of shale oil producers in the US are able to profit even at the current low oil prices.

EIA forecasts a huge but temporary dent in demand for liquid fuel for the first two quarters of 2020


The likelihood of a deal on Thursday as even though oil prices have had a strong rally last Thursday and Friday, it still remains at low levels. This means that incentives for oil producers are aligned to limit production. Coupled with waning global demand, G20 energy ministers are also have interests in limiting oil production at least in the short-term to curb the oversupply and inventory builds that are currently already happening.

Hence, our outlook for Brent crude oil futures are skewed towards the upside, although it may be limited as demand continues to be impacted thanks to social distancing and lockdown measures across the globe. With the coronavirus outbreak likely to continue through Q2, the next indicator for crude oil prices will likely be when lockdowns will start to ease as the number of new cases start to eventually decelerate as a result of the measures in place. Brent may rise past US$35.02 over the week if production cuts are in place. If the agreed-on limit on output reaches 15mn or higher, then Brent crude oil futures will likely rise towards US$40.00 per barrel. But it may be unlikely for Brent crude oil prices to rise past US$45 per barrel in the medium term as a result of weak demand.

Technical Analysis:         


Trading has been relatively thin for Brent crude oil futures as oil traders wait on OPEC+’s meeting tomorrow. Bulls managed to push oil futures up ahead of the meeting as optimism fuelled the upward momentum thanks to reduced tension between Saudi Arabia and Russia. The MACD indicator suggests that Brent is on an upward trend as well. As the likelihood of a production cuts looks more probable now, bulls are likely to be able to charge forward towards the end of the week after the meeting with OPEC+ members on Thursday and then G20 energy officials on Friday. We expect bulls to try to retest the 35.02 resistance level and break it in the event of a production cut. If oil-producing countries limit production enough, then there may be surge in oil prices which could potentially put Brent crude oil futures close to or at US$40.00 per barrel.

Support: 30.00 / 28.63 / 24.81

Resistance: 35.02 / 36.72 / 40.00

Brent Chart (H4)