May 11, 2020

Additional Crude Production Cuts Announced by Saudi Arabia

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Crude prices are poised to gain further support thanks to Saudi Arabia's announcement of an additional cut of 1.0 million barrels per day of crude production. The move by Saudi Arabia is aimed to provide additional momentum to oil prices in a time when product demand and refinery utilization is improving, thanks to the beginning of the relaxation of shelter-at-home orders in several countries.

Saudi Arabia's production will be 7.5 MMBPD for June, according to this latest announced voluntary cut. The announcement arrived today as a part of a wider message from the Kingdom, related to austerity measures and strategies to balance its finances, and is an attempt to attract collaboration of other OPEC countries for additional voluntary cuts. According to statements from the Energy Ministry, the hope is that additional producers can see the benefit of cutting oil production, as a ways to support market prices. (Note that shortly after the announcement by Saudi Arabia -- Kuwait announced an additional cut of 80,000 b/d and UAE announced an additional cut of 100,000 b/d.)

It is clear that the Saudi strategy has shifted, from seeking to gain market share to targeting support for world benchmark prices. If the Saudis had continued to place additional barrels to the Americas or Europe, as they were during March-April, they would had needed to announce deep discounts vs. WTI or Brent for the month of June, and this would had spiraled into additional weakness in spot prices. So, the alternative was to trim production.

But the oil market is not completely out of the woods just yet. Even with this additional cut it is difficult to see crude prices stay above $30/bbl on a permanent basis. For this to happen the market will need to witness additional evidence of lowering inventories and increased demand in the US, and other key markets in Europe and Asia. Given the different pace at which each economies are returning to partial normalcy, the results will take time to be seen.  

Also, it is important to note that the WTI futures contract for June will expire on May 19th, just a few days ahead. At this moment the market could see again a momentary anomaly, maybe not as chaotic as the one from April 20th, but a hectic one nevertheless. When holders of WTI futures contracts did not anticipate with enough time how to complete the rollover to June contracts, or how to work out the physical delivery, the price of front month futures contract fell into negative territory. It will be a good opportunity to see if participants in the futures market will be caught again with difficulty to sell their front month contracts, or if the rollover to the next month is smoother.


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