Brent may stay range-bound in Q1; risks loom in 2020

Last week’s OPEC+ decision to cut output by a further 500,000 barrels a day during the first quarter of 2020 – in addition to the existing cut of 1.2 million barrels a day – has not had the big bang impact on the crude oil prices that one would normally associate with an announcement of this type. On Friday, Brent jumped close to $ 65 a barrel but later corrected to $64.

The decision to take the aggregate production cut to 1.7 million barrel a day for the next three months means that the demand supply fundamentals would obviously tighten slightly, but not tight enough to boost prices dramatically. As it is, the market is expected to face oversupply in the first quarter of next year; and the additional cut of 500,000 barrels will only help slightly reduce the oversupply and nothing more. No wonder, the decision is widely seen as some kind of prop for the market rather than as an attempt to achieve a price target.

Over-production

The reasons are not far to seek. Primarily, there are compliance issues. It is well-known that some producers (mainly Iraq, Nigeria and Russia) are already producing above the quota agreed and allotted to them; and in all likelihood they will continue to exceed the quota. In other words, the real cut may be less than the agreed additional 500,000 barrels.

If the additional cut has to make a marked difference to the market and boost prices, enforcement of quota or compliance is the key. The burden to undertake deeper cuts than agreed to may fall on Saudi Arabia which is interested in higher prices. In fact, the second quarter of 2020 will make for an interesting picture. Whether the oversupply will continue into Q2 will depend on how well producers comply with the decision in the first quarter. Poor compliance will mean even Q2 risk facing some kind of oversupply.

Next OPEC meet

The next OPEC meeting is likely to be held in March 2020 which will review the market conditions. It is possible even deeper cuts may become imperative then. There is also the risk of the agreement coming apart. After all, many producers are keen to retain their market share especially given that the US continues to pump out more and more oil. The US is sure to do its best not to allow the oil cartel to succeed. At the same time, conditions on the demand side cannot be overlooked. Growth across major economies is slowing. The US-China trade war continues with-out a roadmap for resolution, although from time to time we hear noises about agreement between the two warring giants.

In the months ahead, more accommodative monetary policies, anticipated weakening of the US dollar and thaw in the frosty US-China trade negotiations can help boost crude oil prices. Any signal of improving demand conditions is sure to attract flow of speculative capital which will, as is its wont, exert a disproportionately larger impact on prices.

As the world’s largest oil producer currently, developments in the US also need to be watched. Remember that the rig count in the US has been falling and the effect of this will be felt on the market with a lag. That’s the reason why a large oil import-dependent nation such as India has to remain vigilant about crude oil prices all the time.

The writer is a policy commentator and commodities market specialist