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How Will January Output Cuts Affect Oil Trading Markets?

Nick Ferengi's picture
Founder and Editor CAGR Value

Nick is the editor of CAGRValue, a finance blog focused on growth investing, At CAGRValue, we explore the most exciting markets, industries and economies in terms of growth and try to pick out...

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  • Dec 29, 2020
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The price of WTI Crude Oil is just trading about $1.30 below the current 10-month highs reached two weeks ago. This pullback comes just days before the start of the new year, which will see output cuts drop by 500,000 barrels per day to 7.2 million barrels. 

Before the OPEC+ members confirmed the production cuts for January, oil prices had started to drop. However, a significant rebound followed after the announcement of the January output reductions. That boost now appears to have dissipated. There are a few reasons why this may be happening.

First, it is possible that the market has already priced in the expected output cuts in January. According to forex and commodities trader Edward Kendy co-founder at BestOnlineForexBroker.com, “the prevailing oil prices are based on the auction prices in the futures markets which factor in the expected output for the next 3 months, 6 months or more.” As such, the moment the announcement of the new production cuts was made at the start of December, the market automatically priced in the potential impact of a restricted supply of oil in January 2021. 

Oversupply and covid-19 impact

The forces of demand and supply play a crucial role in the oil market. For reference, on April 20, this year, the price of WTI Crude oil slipped to negative pricing amid a slowdown in demand triggered by adverse effects of covid-19, which forced global economies to go into lockdowns. Subsequently, a dispute between Saudi Arabia, OPEC’s biggest oil producer, and Russia, a non-OPEC member resulted in an oversupply of oil, which added pressure to oil prices.

This caused storage problems for oil and gas companies. At negative prices, it implies that oil producers were not only willing to give out oil for free but were also prepared to pay potential suitors to help ease the storage quandary. As such, when the market receives news about output cuts, as is expected in January, this boosts oil prices because the artificial scarcity created by production cuts levels up with the anticipated slowdown in demand.

In January, the world will still be experiencing the challenges created by covid-19. In fact, some countries like the UK have already started partial lockdowns to try to combat the second wave of the pandemic. If the spread of the disease does not slow down in the coming weeks, more lockdown measures could be taken. While it is unlikely that we could go back to the March-May levels, which saw several countries practically close down for business, even 50% of those levels would have a negative impact on oil prices. This is why the OPEC+ members agreed on the January output cuts.

The covid-19 vaccine could boost the market optimism

But still, with the covid-19 vaccine from Pfizer and BioNTech, as well as, Moderna’s alternative being deployed, there is a possibility that the world will not go into another global lockdown as witnessed earlier in 2020. Health experts have called for caution with some suggesting that it would be prudent to go on another lockdown as the covid vaccine is distributed across the world. On the other hand, economists have warned that this could result in more severe repercussions amid the financial crises.

Some reports have estimated that the vaccine could reach some parts of the world as late as the fourth quarter of 2021. This is despite the fact that the US and the UK have orders hundreds of millions of doses, more than what is already available. 

Conclusion

In summary, it could actually take longer than a year for the vaccine to reach every corner of the world. Nevertheless, combining the mitigation measures being taken with vaccinations could limit the adverse effects on the economy, which in turn will boost energy requirements. And since oil prices are based on futures contracts as described by Edward Kendy of BestOnlineForexBrokers.com, the expected positivity could actually boost oil prices as early as during the first quarter of 2021.

Nick Ferengi's picture
Thank Nick for the Post!
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Matt Chester's picture
Matt Chester on Dec 29, 2020

It's been notable to see the continued compliance of OPEC members with cuts-- I think they're seeing that that collective action is even more critical amid these crises to keeping their market control than it even had been previously

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