The out and out oil price war has now entered its next phase and has become the chess game that is the new contest for market share. The trigger for this shift was always going to be China's resurgent crude oil imports and the seeming revival of a region that appears to have put the worst of the COVID-19 pandemic demand destruction behind it
After OPEC+ alliance on Saturday decided to amend their agreement and maintain the current production cuts levels into June, the Saudis hit the market with its OSP forits flagship Arab Light.They clearly now feel confident enough to raise the price by $6.10 and they also raised prices on other grades for sale into the Asian market by between $5.60 and $7.30. I would be surprised if this was not some sort of pre- negotiated Russo-Saudi pact.The mutually destructive price war, an ill wind that blew no one any good, has been replaced with symbiosis, a far more productive and mutually beneficial existence.
At a time we hear so much about flattening curves, their focus seems to be on controlling the front end of the price curve and although the market remains in contango, the curve has certainly flattened. The apparent harmony amongst OPEC+ alliance is driving market sentiment and prices are responding despite historically high inventories. Though speculation has played its part in the recent price rally which suggest a market correction once profit taking begins.
Such management is necessary, yet it remains to be seen on how effective it will ultimately be. As oil benchmarks recover, US producers such as EOG and Paisley who cut production quite substantively in May have indicated their intention to turn the pumps back on. They are by no means alone. In fact with WTI trading at almost $40 a barrel it has passed the break even point for many US Shale producers. The return of US volumes to a market that has recovered largelybecause theOPEC+ alliance extended production cuts is potentially problematic. It would be unconscionable for countries like Nigeria who have devalued their currency and reduced their budget. It will be interesting to see if the current narrative which is centred onenforcing compliancewithin the OPEC+ alliance, alters as and when US Shale comes back online.
The increase in Saudi oil prices to Asia and an extension of production cuts suggests to me that the Russians and Saudis have come to an accommodation regarding the Chinese market, which is the great prize. Russia have become the largest crude oil supplier to China according to the most recently released customs data for April.They leap frogged the Saudis with anaverage of 1.75 million bpd compared to1.26 million bpd.Iraq was the2nd largest supplier and who are under severe pressure from both Russia and the Saudis to comply with theirOPEC+ quota which they exceeded by over 400,000 bpd (most of which went to China). Discretion they say is better than valour, reducing Iraq's ability to supply the Chinese market allows Russia and the Saudis to increase prices and divvy up their market share.
In a sign of the bizarre times that we live in US. energy secretary Dan Brouillette tweeted "I applaud OPEC+ for reaching an important agreement, which comes at a pivotal time as oil demand continues to recover and economies reopen around the world,".
He was echoing the sentiments of President Trump who previously threatened to pull US troops out of Saudi Arabia if Riyadh did not act. President Trump spoke to the Russian and Saudi leaders before Saturday's talks, saying he was happy with the price recovery. Only acouple of months ago the US law makers were clamouring forthe No Oil Producing and Exporting Cartels Act (NOPEC Act) stripping OPEC member states of their sovereign immunity and seizing their assets..
Arriving at a price that is acceptable to all the market's key stakeholders is the difficulty theOPEC+ face. As demand inevitably recovers and as economies emerge from lockdowns, micro managing the market to maintain some sort of equilibrium is the biggest challenge. The OPEC+ alliance are likely to address production quotas on an ongoing basis, perhaps month-to-month. Shale is the complication. Ideally Trump would want to see a vibrantdomestic energy industry in election battleground states such as Texas, yet increased shale production could be what collapses the price benchmarks. Even if demand returns and refinery utilisation rates rebound, there is an awful lot of inventory build to draw upon. In an ironic twist of fate, Trump could find himself relying on a cartel he has in the past lambasted to manage the market for him.