Chart of the Day: Big swings for oil as traders weigh up OPEC+ deal
We saw a big swing in crude oil futures early in the asian session after OPEC and a raft of other oil producing nations struck the biggest ever supply cut deal, ending the month-long price war between Russia and Saudi Arabia. While a total cut of 14.7 million barrels per day is an unprecedented measure, it will be a big week for oil as traders weigh up the impact on the global lockdown-induced oil slump, which has reduced demand by an estimated 35 million barrels per day.
Traders were hesitant to take WTI crude (XTIUSD) above $30 per barrel in last week’s trading, forming resistance at the 30 handle just below the 23.6% Fib retracement of the 2020 sell-off, at 31.10. An attempt to break higher was short-lived as prices sold off late in the Friday session as an initial deal couldn't be reached.
We’ve seen big moves in XTIUSD this morning, which you can see on the 15-min chart above, partly driven by lower Easter Monday liquidity, but also as traders weigh up the daily 15m barrel production cuts against the pandemic-induced demand slump of 35m barrels daily. Futures sold off 5% on the open but have steadily tracked higher since.
I’ve got my eye on the 23.6% Fib retracement at 31.10 this week. A break above here would indicate a punchy move higher, however looking a bit closer at the detail of this OPEC+ deal and considering the demand slump, it feels like rallies will eventually be sold, continuing the drift towards $20 per barrel until traders can see global lockdown restrictions being lifted.
Prices sold off late on Friday after OPEC+ and allies failed to reach an initial deal. Mexico insisted on production cuts of only 100k barrels per day, far below the expected 400k. But with some questionable maths, or creative accounting if you will, President Trump negotiated that Mexico could count some of the USA’s organic supply cuts as its own. OPEC+ agreed.
So OPEC+ has contributed a daily output cut of 9.7m barrels per day, with an additional 5m daily cuts from non-OPEC nations including the US, Brazil, and Canada. The deal will come into effect on 1 May, giving producers almost three more weeks to drown markets in a surplus of crude. But the full OPEC+ production cuts of 9.7m will be short-lived, with production to increase by June, when cuts will total a smaller 7.6m. Production will increase again at the end of this year and when cuts will total only 5.6m, which should hold until April 2022. This is a long-term game, and the cuts might not be felt until lockdown restrictions are lifted globally and demand picks up again.
Look even closer at the detail and you see that for many countries, the reduced output is in the form of organic cuts, meaning production cuts that have already occurred naturally in the demand slump. This was offered by USA and some other G20 countries and was assumed a dealbreaker last week, however got over the line by Sunday night. This means that these organic supply cuts might not be felt until production resumes pre-COVID levels, which could be months or even years away.
The Russia-Saudi price war has ravaged markets and industry across the globe, inflicting particular harm on US producers. No US energy producer can balance its books with prices below $30 a barrel, and some are facing bankruptcy. Major US lenders are prepared to stand in and operate oil and gas fields to avoid losses on loans to energy companies.
Whichever way oil prices move this week, and the magnitude of the move, will ricochet to many other assets across financial markets. I looked at this in depth last week, but broadly a move higher in oil prices should see a bid in many shares, indices, petro- and commodity currencies. If oil prices fall, any recent gains could well be reversed. I have a close eye on AUDUSD, which found a nice bid higher last week in anticipation of supply cuts and higher oil prices.
Chart of the day: What takes WTI crude to $20 a barrel?
Oil prices have fallen more than 50% this year as global demand plummets and sees oil on track for the biggest contraction in history. Add to that a fierce price war between major oil producers, WTI crude (XTIUSD) continued its downtrend closing at $26.95 per barrel in yesterday’s trading. So what takes oil to $20?
The continued fall comes before Saudi Arabia and Russia ramp up supply early April. Of course markets are anticipating the supply increase, but just how big will the surplus be? The markets could be facing the largest oil surplus in modern history, which would push prices markedly lower. Watching how the surplus ramps up will determine if and how soon WTI crude (XTIUSD) hits $20 a barrel.
Of course, demand is also sinking as countries take unprecedented measures to combat the virus outbreak, stalling demand for air travel which threatens to bankrupt major global airlines.
Falling oil prices, while great for the consumer, are worrying for major companies and often considered a recession barometer. In good times, companies ramp up production to meet increasing demands. Low prices show the oil market rut, which ricochets to the wider economy. Concerns ramp up when you consider that some major companies’ success is tied to higher oil prices. Energy companies like Exxon Mobil (XOM.N) and Chevron (CVX.N) obviously among them.
Low oil prices will be contagious for the financial sector. When prices are high, banks pick up business from energy companies who need financing for new projects. Such projects are too expensive when prices are low. In fact, it’s estimated that around $30 per barrel is when prices become unprofitable for US energy producers.
As oil producers cancel new projects, this also hurts steel and heavy machinery. Companies like Caterpillar (CAT.N), which provide machinery to the industry, will feel the pinch of lower oil prices too.
Separate from the coronavirus pandemic, the price war would be enough on its own to spook financial markets and jeopardise energy producers. Bail out, anyone?
Chart of the day: Oil traders should be watching $50.70
After last week’s punchy 7.4% drop, taking price through and below, all short and long-term moving averages, we now eye a move into $50.70, which has been the obvious buy zone over the past 12 months.
The last time we honed into these levels was in October and it proved to be the platform for crude to rally strongly into $65. What we’re seeing is obviously a demand shock and the idea that China, the world’s largest importer of oil, will struggle to maintain demand, notably for jet fuel, going forward, as the public refrains for overseas and domestic flights.
One suspects that a move into $50.70 will be met with solid buying support, with traders looking to support a commodity that is already technically oversold. Consider the probability that OPEC will presumably increase its verbal support of price at these levels, offering a view they are looking at production levels - although this is not really a supply issue.
While I expect some defence of $50.70, should it trade here, let's consider that a subsequent break of $50.70 would hold huge implications for financial markets more broadly. It’s not just equity markets that will struggle, but petrocurrencies (NOK, CAD, and USD to an extent) would underperform against the JPY and CHF, while inflation expectations will see interest rate cuts being more readily priced in. Keep oil on the radar.
Head of Research