The big first question every energy industry executive, trader and government bureaucrat should be asking in the current oil market is: What is already priced in?
With oil prices at near lows for this century, everyone in the industry is on edge. Traders are unsure of what’s happening. And countries that produce oil are worried about their economies and their budgets. But they can’t begin to make plans, take positions or set policy without an idea of what the current market has already considered in setting these low prices.
Tomorrow, April 9, OPEC+ will conduct a virtual meeting to discuss a new production cut agreement. Much has been said already about this meeting and about the G20 oil virtual meeting that will occur on the following day. There are reasons for Saudi Arabia, Russia and others to want a production cut. There are also reasons each of them may refuse to go along. There are limits to what the U.S. can do about a production cut because of its free market system and legal protections for companies. At this point, this all should be understood by industry, traders and policy makers.
But what matters in the short term—especially for traders—is how the market will respond to whatever happens in these meetings. What expectations are priced in for the meetings this week?
There is some reason to believe that the market expects some agreement at the end of this week, as the prices of oil rise midday in the U.S. market. If the market expects an agreement, then no agreement or a limited agreement will disappoint the market. If, on the other hand, the market does not expect an agreement, then prices could rise substantially if a good agreement is reached.
(Remember, the reaction to the meetings may be impacted by the timing of the meetings. Friday is also Good Friday and a holiday for much of the world. Monday, the day after Easter, is also a holiday for parts of the world as well).
Organic Supply Numbers
The meetings this week are only one way that supply numbers may drop. Supply numbers can also drop organically because producers have nowhere to send their oil, because producers believe it is best to decrease production at current prices or because producers can no longer afford to continue operating wells. What is priced in for organic supply decreases?
Is there any expectation that U.S. shale production will drop precipitously or that the decline will take a little longer? Is there an expectation that a lack of storage space will lead to production declines? And, if so, when are those declines expected to begin?
If the organic supply declines surpass expectations, oil prices will rise on the result. If they are less than expectations, oil prices will fall.
The biggest problem facing the oil industry is a decrease in demand largely created by the global reaction to coronavirus. There are different projections for when economies will come back online and what type of local and global recessions or depressions will result. Currently, it is estimated that demand has already dropped between 10 million and could drop by more than 30 million barrels per day. What is priced into the market for demand decrease?
What has the market already priced in for current demand drop? When does the market believe demand will begin to return? How long will it take to return to pre-coronavirus demand levels? When will travel and manufacturing return to previous levels? How will the economic slowdown play out?
All of this is priced into the market and the market will continue to adjust based on new data and sentiment. The issue is determining how the market priced it in. When some new information comes along that changes the perception, the oil market will move.