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Extending production cuts would be “suicidal” for OPEC

OPEC + will hold a committee meeting this week to assess the state of the oil market and decide on its next steps. For now, the group appears to be ready to begin unwinding extraordinary production cuts, which could test the recent price spike. The historic 9.7 million barrels per day (mb / d) cut OPEC + implemented after the pandemic-related collapse was always thought to be temporary. Initially, the cuts were due to expire in late June and begin to taper off in early July; The group agreed to extend that first phase for one month.

The cuts are currently expected to expire in late July, reducing the cuts from 9.7 mb / d to 7.7 mb / d. Various press reports have suggested that the group is willing to let those cuts slow as planned, rather than press for another extension.

Russia intends to boost output in August, and OPEC + delegates “lean” to relax cuts, according to a report by Bloomberg. He Wall Street Journal He reported a similar point of view, adding that OPEC + producers are reluctant to continue to bear the brunt of rising prices, while non-OPEC producers worldwide are restarting their own production. “If OPEC sticks to the restriction on production to keep prices high, I think it is suicide,” he told the WSJ a source familiar with the Saudi strategy. “There will be a fight for market share, and the trick is how low-cost producers prevail without dropping the price of oil.”

Keeping 9.7 mb / d off the market helped achieve a price rise to $ 40 a barrel and created an atmosphere of stability. The big question now is how the market will react to the easing of those cuts. “It has been anything but a bumpy journey for oil over the past few months and the OPEC + supply deal has been a mainstay for the market,” said Louise Dickson, oil market analyst at Rystad Energy, in a statement. “This week’s upcoming OPEC + meeting, as planned, is expected to make this pillar a bit weaker.”

Dickson added that “it is not necessarily a bad thing” that OPEC + increases production as “supply would have to grow as demand recovers.” Demand has rebounded sharply, although it remains below pre-pandemic levels.

The problem is that it remains incredibly difficult to calibrate supply additions to fit the demand recovery path. The delicate balancing act is even more difficult because demand may decrease again due to the spread of the coronavirus. “What OPEC + may not have accurately predicted is the speed of the recovery, so a premature partial lift of restrictions on oil production can have a depressing effect on prices,” Dickson concluded.

Other analysts are less concerned that OPEC + will recover the offer. “Our balance sheets show strong deficits in the third and fourth quarters, even with a decrease,” said Bob McNally, founder of consultancy Rapidan Energy Group, to Bloomberg. “I think the market will handle it quite well.”

If demand continues to rise, the “call to OPEC” will “rise massively” in the second half of the year, Commerzbank said in a note Monday. “The oil market is therefore heading for a clear supply deficit, so OPEC + is likely to decide on Wednesday to gradually withdraw the record of production cuts of 2 million barrels per day – as planned – to from August ”, said the investment bank.

Meanwhile, the Libyan news is murky. The National Petroleum Corporation recently lifted the force majeure on oil exports and said it would start adding supply back to the market. However, over the weekend, the Libyan National Army said the blockade would continue. In response, the NOC once again declared force majeure on Sunday, accusing the United Arab Emirates to back up the lock. The return of Libyan oil, if it occurs, will probably be gradual. As such, it may not add too much to the overall offering.

Another additional source of supply – US shale – may not be as large as previously feared. In the past, any restrictions in the oil market simply created more space for aggressive shale drilling. But the number of drilling remains at record lows, despite rising oil prices to $ 40, and financial stress could keep drilling low. As steep decline rates take hold, it seems unlikely that US production will return significantly this year or next.

This creates more room for OPEC + to undo its cuts, although the coronavirus remains huge uncertainty.

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