Saudi Arabia’s 'lollipop' has yet to sweeten oil prices

Benchmark oil prices were largely unchanged after Sunday's OPEC⁺ meeting at which Saudi Arabia said it would make a voluntary unilateral cut of 1 million barrels per day for the month of July.

In the physical oil market, where any short-term production cut should have the greatest and most immediate impact, the calendar spreads between nearby months strengthened only slightly.

For dated Brent, the spread from July to August was quoted in a backwardation of 17 cents per barrel on Jun 5 up from 10 cents on May 31.

The calendar spread from August to September also firmed to a backwardation of 46 cents per barrel up from 32 cents at the end of May.

Both remained below recent highs of 60-70 cents recorded after OPEC⁺ unexpectedly announced the last round of output cuts in early April.

In the financial market, where trading is further forward, the Brent futures spread for the fourth quarter tightened into a backwardation of around $1.20 on June 5 up from 86 cents at the end of May.

The futures spread has weakened progressively for six months as the global economic outlook has deteriorated and the anticipated strong rebound in oil consumption in China has been pushed back.

The tightening of both physical and futures spreads following the unilateral Saudi production cut announced at the OPEC⁺ meeting on Jun 4 was much smaller than that which followed the unexpected cuts on Apr 2.

The unilateral Saudi cut, described by the country’s oil minister as a “lollipop”, is for a month, but could be extended.

Some sort of cut was anticipated and priced in by traders after the minister issued a warning to short sellers just over a week before.

So although the cut has had little discernible impact on spreads and outright prices, it is likely both would have slumped further if it had not been announced.

STEMMING THE SLIDE

There is evident frustration among OPEC⁺ officials about the continued slide in prices despite three rounds of cuts announced since October 2022.

Some have dismissed this as the impact of speculation, especially from short sellers, which has masked the impact of market fundamentals of tightening production and consumption.

In practice, discriminating between speculation and fundamentals in this way is unhelpful.

Speculators tend to anticipate, accelerate and amplify price changes set in train by fundamentals, rather than cause them, and perform this role throughout the cycle.

Speculators were as much responsible for anticipating, accelerating and amplifying prices when front-month Brent climbed to a high of more than $120 per barrel in March and June 2022 as they were when it fell to a low of $72 in May 2023.

The implied production-consumption-inventory trajectory for the whole of 2023 has softened considerably since November 2022, translating into lower prices and weaker calendar spreads:

The expected rebound in China’s consumption after the exit wave of the pandemic has taken longer to materialise and been weaker than expected.

The major economies of North America and Europe are stuck in an industrial recession and the slowdown is spreading from manufacturing to the much larger services sector.

Russia’s crude and fuel oil exports have remained high despite European Union and US sanctions and the country’s promises to other OPEC⁺ members to reduce output.

US oil production has continued to rise in a delayed response to last year’s very high prices, which has also kept the market well-supplied.

Multiple rounds of production cuts by OPEC⁺, including the recent unilateral cut by Saudi Arabia, have counteracted some of that weakness and kept prices higher than they would otherwise have been.

After adjusting for inflation, front-month Brent prices are trading in the 45th percentile for all days since the turn of the century, which is quite high given the downturn in global manufacturing and freight.

But OPEC⁺ cuts have not (yet) been enough to lift prices and spreads rather than arresting their fall. That will come when the outlook for the global economy and oil consumption shows signs of starting to improve.

At that point, speculation will anticipate, accelerate and amplify the cyclical price upturn.

John Kemp is a Reuters market analyst. The views expressed are his own.