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OPEC Had Better Get Used to $50-Or-Lower Oil

By Investing.com (Barani Krishnan/Investing.com)CommoditiesFeb 28, 2020 01:29PM ET
www.thechinesenews.net/analysis/opec-had-better-get-used-to-50orlower-oil-200511745
OPEC Had Better Get Used to $50-Or-Lower Oil
By Investing.com (Barani Krishnan/Investing.com)   |  Feb 28, 2020 01:29PM ET
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With Russia finally ending its cat-and-mouse game with OPEC, the world alliance of oil producers hopes to shock the market into a rebound next week by announcing a cut of more than one million barrels per day in output.

No matter what the cut ordained by the Organization of the Petroleum Exporting Countries, the cartel may have to live in an extended period of oil at $50 per barrel or lower as the disruptive forces of the coronavirus continue tearing through the global economy.

As benchmark Brent and U.S. crude futures headed for their worst week since 2016, amid year-to-date losses of about 25% each, Russia emerged from the shadows to say that it wanted to continue cooperating with OPEC on production cuts.

WTI Futures Weekly Price Chart
WTI Futures Weekly Price Chart

OPEC Secretary-General Mohammad Barkindo also said there was “renewed commitment” in the OPEC+ alliance “to build the consensus for joint action ... in mitigating the current hyper volatility in the market”.

The Financial Times followed this up by saying the Saudis were trying to commit those in OPEC+ — mainly, Russia, of course — to a collective production cut of an additional million barrels per day. While the details will likely be known only at the group’s March 6 meeting in Vienna, the takeaway was a cut “significantly higher” than the 600,000 bpd initially proposed.

But This Is A Demand Problem, Not Oversupply

The bottom line is OPEC is treating this like any other oversupply crisis in oil and trying to cut its way out of it. It’s a standard defense mechanism for the cartel — in fact, the only one it knows, the only one it can logically use and the only one that’s worked since its founding 60 years ago.

Output rationing is probably a strategy that will work again for OPEC in bringing the market back up to some respectable level. But it probably won’t happen as quickly as OPEC desires.

In fact, OPEC might have to live with a frustratingly long range-bound period of $40-$50 oil. That’s because this is a demand crisis — unlike the typical oversupply situation the market has often found itself in the past six years, thanks to the U.S. fracking boom and cheap shale oil.

Brent Futures Weekly Price Chart
Brent Futures Weekly Price Chart

Compounding the problem for oil now is a tottering U.S. stock market that could turn into a bear market in a matter of days or weeks. The correlation between oil and equities cannot be disputed. Wall Street’s continued crash poses a terrifying specter for those long crude, not to mention those who had bet on continued record highs in stocks till U.S. elections in November, when President Donald Trump will be seeking a second term.

To better understand the current situation in oil — and determine how realistic a chance the market has for recovery — a journey back into December 2018 will help. Trapped in another supply glut then forced by Trump’s unexpected sanction waivers on Tehran — which the flooded the market with Iranian oil — OPEC+ announced a 1.2 million bpd cut on Dec. 7 that year.

But it wasn’t until after Christmas 2018 — nearly three weeks later — that the rebound came. WTI still ended December 2018 down almost 11% — not too far from the 9% decline for the S&P 500 that month. From there, in almost mirror-like fashion, U.S. crude and Wall Street’s top stocks gauge moved in unison through 2019.

Oil-Wall Street Correlation Cannot Be Understated

If the harmony that existed between oil and equities then was valid, the collapse in both now shouldn’t surprise. As OANDA’s analyst Jeffrey Halley noted in his Friday commentary, the market carnage brought by the virus has now hit everything from stocks to bond yields and even the dollar. It simply meant that nothing was sacred and, if anything, things would get worse before they got better.

The December 2018 model of the oil-stocks relationship also gives an insight into the quagmire that possibly awaits crude prices this time.

Then companies like tech giant Apple (NASDAQ:AAPL), beer and spirits maker Constellation Brands (NYSE:STZ) and homebuilder Lennar (NYSE:LEN) were all issuing profit warnings, saying they’d miss quarterly earnings forecasts due to economic uncertainties.

Fast forward to February 2020 and we have Apple’s guidance that it doesn’t expect to meet second-quarter forecasts; Microsoft's (NASDAQ:MSFT) caution that it will likely miss fiscal third quarter expectations; and Nike Inc (NYSE:NKE) saying it has closed about half its stores in China while experiencing lower-than-expected retail traffic at the rest.

Can the stock market and oil both be helped by economic stimulus, specifically a rate cut?

Maybe and maybe not, Moody’s Analytics said in a note on Thursday.

The ratings agency said the Federal Reserve may have to restart an easing cycle it ended in December if there were signs that the U.S. economy, which was into a record 11th year of growth, was under serious threat from the coronavirus. Speculation has mounted this week the central bank may announce a half point cut in rates at its upcoming policy meeting in March.

Rate Cuts Might Help, But Not Do The Job Entirely

Yet, given the uncertainty spawned by the virus, “Fed rate cuts may fall short of stabilizing markets,” Moody’s Analytics added.

The ratings agency said it expected the U.S. economy to grow by an annualized rate of 1.3% in the first quarter, down by 0.6% point because of the virus. Growth for all of 2020 was seen at 1.7%, down 0.2% point.

Breaking down the forecast, it said:

“Our previous assumption that the virus will be contained to China proved optimistic, and the odds of a pandemic are rising. We previously put the odds of a pandemic at 20%, but we now put them at 40%. A pandemic will result in global and U.S. recessions during the first half of this year. The economy was already fragile before the outbreak and vulnerable to anything that did not stick to script. COVID-19 is way off script.”

The implications for oil will be worse if U.S. consumer sentiment — which is responsible for 70% of the country’s growth — tanks. Forget the slowdown in retail or shopping. Simple behavioral changes like not going out to the movies, dinners or canceling travel plans because of pandemic concerns can have a huge impact on the economy — not something OPEC supply cuts can easily solve for oil.

“This is a global crisis that we still haven’t come to see the full magnitude of it. And it could be unlike any crisis really in our lifetime outside of a world war, in that the entire world gets seized up because of the spread of this virus,” New York Times op-ed columnist Tom Friedman said.

OPEC Had Better Get Used to $50-Or-Lower Oil
 
OPEC Had Better Get Used to $50-Or-Lower Oil

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Comments (16)
John Smith
John Smith Mar 01, 2020 8:18PM ET
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Useless article... Not a single clue in it... Share of shall oil have been destroyed by 80%...how long do you think it is sustainable?... How do you know that the shall oil industry will not collapse? How do you know that the Corona virus will not bring back inflation due to less workers available? If inflation comes in, interest rates will go up and the shale oil industry will unstainable at last... Then you will lack the investment in the usual oil business and the price for oil will soare..
samer abbas
samer abbas Mar 01, 2020 6:54AM ET
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Sooner or later, the investors/markets will absorb and digest COVID-19 and will bounce back rapidly. Oil prices will recover soon and will range between $54.56
Ramm Batts
Ramm Batts Feb 29, 2020 8:56PM ET
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Typical NY BS
Ramm Batts
Ramm Batts Feb 29, 2020 8:55PM ET
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At below 50 US willlose 40000 jobs not happening
Joshua Hunt
Joshua Hunt Feb 28, 2020 4:32PM ET
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over reaction alittle? i see oil prices rebounding to 60+ in 4 to 6months..if the cv goes away.
Mike Hads
Covfefe Feb 28, 2020 2:58PM ET
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Very good article.. Demand problem indeed. But, the ME will not tolerate burning massive amounts of cash like they did with their failed experiment in 2016. There is always an equilibrium to supply and demand and they will do what is necessary to get there.
Jose Emenis
Jose Emenis Feb 28, 2020 12:56PM ET
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Goldman Sachs is shorting gold and silver in order to drive investors back into overpriced securities like Facebook, Apple, Amazon, and Google....
Barani Krishnan
Barani Krishnan Feb 28, 2020 12:56PM ET
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I wouldn't be surprised at all. GS has been doing this forever.
inderjeet virk
inderjeet virk Feb 28, 2020 11:05AM ET
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further opec cuts will not fix the problem but one thing is for sure what harm opec had not done to the shale oil this virus will definitely do.
Barani Krishnan
Barani Krishnan Feb 28, 2020 11:05AM ET
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That may happen.
greg mason
greg mason Feb 28, 2020 10:31AM ET
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$30 - 33  is possible
Barani Krishnan
Barani Krishnan Feb 28, 2020 10:31AM ET
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Very likely. No bottom in sight for now.
icouldnotthink67 .
icouldnotthink67 . Feb 28, 2020 8:48AM ET
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Once everyone starts having this mindset is usually when the prices skyrocket. Might still drop a ton short term though. This might just bankrupt shale so the big players control it all.
Barani Krishnan
Barani Krishnan Feb 28, 2020 8:48AM ET
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The rebound is usually V-shaped depending how the economic recovery is as well.
Peter Weiss
Peter Weiss Feb 28, 2020 8:23AM ET
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Might be... but remember that there are out there many geopolitical and economical interests that will push it higher. The coronavirus as history shows will not last long... and even if it does we will get used to it and/or control it.... life goes on
Barani Krishnan
Barani Krishnan Feb 28, 2020 8:23AM ET
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Yes, Peter. It's a battle between the virus and consumer confidence.
Lion King
Lion King Feb 28, 2020 8:17AM ET
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low oil price means low sells in all the world. in other hand you can say . the western countries should be ready for low sells ... close some shops and cut some jobs ...
Barani Krishnan
Barani Krishnan Feb 28, 2020 8:17AM ET
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Next 3 months will be pretty intriguing.
Jose Emenis
Jose Emenis Feb 28, 2020 7:43AM ET
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Donald Trump said the coronavirus will disappear when the weather gets warmer in 2-3 more weeks....
Barani Krishnan
Barani Krishnan Feb 28, 2020 7:43AM ET
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There is history that the flu doesn't work as it should in higher temperatures. There is history of a president who can't take bad news.
Jose Emenis
Jose Emenis Feb 28, 2020 7:43AM ET
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Barani Krishnan Trump is holding MAGA rallies all over the country and the world while the coronavirus spreads like wildfire.... Trump ignored the coronavirus crisis.... This is Trump's fault... He's supposed to be the leader of the "free world"....
Barani Krishnan
Barani Krishnan Feb 28, 2020 7:43AM ET
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Jose Emenis  Not much tweeting the past two days. Probably thinking of new ways to blame his rivals for this.
Claudio Andretti
Claudio70 Feb 28, 2020 6:31AM ET
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I agree. "he odds of a pandemic are rising" and a pandemic is the real enemy of financial markets for the most elementary reason: people are consumers. If people get scared or worse die, no more spending. Now, what could help and boost the chances of a recovery? 1) a rate cut, as you say 2) spring and summer. Cold weather is an ally of this virus, warm and hot weather should help. Consider that even if the virus should fade, the Fed rate cuts would not. 3) Trump. He promised a fiscal help. Who on earth is going to tell him now that the deficit would rise too much? I'm not sure Trump is disappointed with this crash, taking place more than 8 month before the elections and due to external reasons. He can always say "as long as things depended only on me, everything was fine. Let me fix everything once again (by the way, the virus comes from China, I was right once again)". Could these things explain why Gold is dropping instead of rising (with stocks, yields and Usd falling)?
sharath naik
agsn Feb 28, 2020 6:31AM ET
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Oil prices are tied to the Demand and Supply difference. OPEC always reduces supply to keep the price above 50$. The only time oil ever dips below 50$ is if the demand is constantly falling and supply cuts are lagging behind the demand drop.  For this, you need a long sustained demand drop. This is unlikely in this scenario, the flu season starts going down in summer, which is the end of March.  There is no foreseeable 6-month long virus-related shutdowns, it is going to get worse for the nex 2 months and star recovering as the flu spreads to other places(Less oil using countries).  But it will get really worse with Iran being the primary exporter of this virus through out the world.
Barani Krishnan
Barani Krishnan Feb 28, 2020 6:31AM ET
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Next 3 months will be crucial.
Dev Nandan
Dev Nandan Feb 28, 2020 5:26AM ET
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$45.. Will sustain till end of March.
Natty Long
Natty Long Feb 28, 2020 5:16AM ET
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Dude are you serious?
lee hine
lee hine Feb 28, 2020 5:16AM ET
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No it was a joke
Barani Krishnan
Barani Krishnan Feb 28, 2020 5:16AM ET
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Natty Long, look at the S&P before you laugh.
 
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