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If producers’ cartel OPEC fails to delay a production hike then history suggests we could see a big fall in the commodity price
Thursday 22 Oct 2020 Author: Tom Sieber

The price of oil has proved resilient in recent months with the global benchmark Brent Crude still above the $40 per barrel mark it has largely held since the summer. However, the market now faces a key test as producers’ cartel OPEC and Russia announce their next big decision on production quotas.

Output cuts of 7.7 million barrels of oil per day are scheduled to be tapered to 5.8 million in January 2021. However, the market appears to be pricing in a delay to this move and will find out if this hypothesis is correct at a meeting in Vienna on 30 November.

If OPEC, dominated by Saudi Arabia, doesn’t delay plans to increase production we could see a similar scenario play out to that seen in November 2014 where the oil price collapsed. It fell from well above $100 per barrel in June of that year to less than $30 by January 2016.

It seems unlikely the same mistake will be repeated six years on, however ensuring compliance may not be easy as producing countries face the unenviable choice of giving up on potential oil revenue or risk flooding the market and undermining prices.

In 2020 the issue is largely centred on demand rather than supply as the pandemic and its accompanying travel restrictions have led to a drastic reduction in the use of both petrol for cars and jet fuel for a grounded aviation sector.

Bank of America estimates that 2020 will see oil demand down 10 million barrels of oil per day on average led by transport fuels. It says: ‘In aggregate, oil demand could take two to three years to reach pre-Covid levels, but this will be heavily dependent on when a vaccine is readily available.’

This has ongoing implications for oil majors BP (BP.) and Royal Dutch Shell (RDSB) and their ability to sustain dividend payments which have already been scaled back significantly earlier in 2020.

Investment bank Morgan Stanley says: ‘At the moment, Big Oil’s outlook is particularly cloudy. Perhaps, in the fullness of time, it may become clear that “now” is actually the moment to build positions (buying shares in the sector). However, further downside risks are also still surprisingly large, in our view.’

It added that in the medium-term the capital expenditure associated with a shift to renewables could put pressure on the sector’s capacity for dividends, perhaps leading to more cuts.

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