Is the crude output agreement falling apart?

G Chandrashekhar | Updated on September 04, 2019 Published on September 04, 2019

No solace In India, the benefit of moderate crude oil prices is neutralis ed by a weakening rupee   -  Angus Mordant

Notwithstanding the cautious optimism expressed by many observers over global growth, crude oil – the universal intermediate – has been under pressure in recent times due to a combination of factors, including the stronger dollar and the ongoing trade war between the US and China.

Brent crude has been hovering around $60 a barrel, supported by financial investors, and to an extent, disruption in Venezuelan oil supplies. However, there is now an increasing belief that the discipline among producers, who had agreed to an output cut, is becoming tenuous. There is reason to believe that many producers have begun to raise output.

A report suggests OPEC’s daily production in August increased by 200,000 barrels to 30 million barrels a day. Nigeria and Iraq are seen producing more. Saudi Arabia too has produced more, but still below the limit it has set for itself. OPEC’s most important ally Russia too has begun to produce more, although it is clear that Russia was not a wholehearted votary of output cut.

Demand concerns

The question is whether rising output will become the trend in the months ahead. In the event, it is only a matter of time before the current tightness in supplies eases. Coming on top of demand concerns – major economies are slowing – rising supplies are sure to wean speculative capital away from the market.

Also, lack of discipline may prompt parties to the output cut agreement to disregard their commitment, exacerbating the supply situation. Evidence of this is provided by the market itself. Futures prices for Brent crude on ICE are in a state of backwardation until the end of 2021. This clearly reflects the perception of the market participants.

US production

The market is also closely tracking developments in the US where oil production continues to surge. However, there are concerns over the sustainability of US oil production in the quarters ahead. The rig count in the US is declining and currently stands at its lowest level since the end of 2017. At the same time, in the event of a growth slowdown, the US demand will need a close watch.

All these are sure to lend increased volatility to the crude oil market. There are supply side and demand side factors operating.

How the US-China standoff over tariffs pans out will be a key factor. The general feeling is that global growth slowdown is inescapable.

But, at the same time, there is a seemingly coordinated move by central banks of major economies to make the monetary policy more accommodative to support growth.

Higher liquidity or low cost of money usually boosts commodity markets. We have seen in the past liquidity driven commodity boom.

Current reckoning

On current reckoning, it stands to reason to believe that Brent crude may continue to hover around the $60 a barrel levels till the end of the year, unless there is a major market impacting development.

For India, a major importer, the anticipated price level should be a matter of some relief or consolation. However, the benefit of moderate prices is somewhat neutralised by a weakening rupee.

The writer is a policy commentator and commodities market specialist. Views are personal

Published on September 04, 2019
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