Could Brent reach $70?

Could Brent reach $70?

Brent and WTI futures are down for the day, settling at around $40.89 and $38.35, respectively. However, this is after a six week over week gain since the peak of the Coronavirus. As people start returning to a relatively normal, the demand for oil is slowly picking up. The increase in the price of oil may be attributable to this; however, the bulk of this may be due to the 9.7 million barrels per day (mbs) cut OPEC has implemented. There are concerns about the possibility that demand will take some time to recover / never recover. However, that is irrelevant as it is about how the supply/demand balance is. Demand may not improve in the short term. However, with OPEC extending the duration for how long these deep cuts are implemented, demand is soon to outstrip supply causing a boost in the price.

OPEC’s actions dictate the future of Brent and WTI

OPEC countries have a history of not adhering to the said cuts – primarily smaller producers, which have heavily relied on Brent exports to fund their government. However, it has been a tentative two for two with the OPEC countries agreeing to the initial cuts and the extension of the cuts. This collaboration and unity are due to a common enemy with all the producers – the Coronavirus. A common enemy unites everyone to a common goal until the goal of price breakeven is reached. With a breakeven price of around $60 for most OPEC countries, including Saudi Arabia, the goal of price breakeven is far from achieved. This leads to suggest that OPEC countries will continue to collaborate at least that breakeven price.

Effect of the supply cuts

Apart from the apparent supply and demand factors pushing the price higher, OPEC is trying to draw down the billions of barrels of oil in storage that raised capacity concerns and negative prices.

During the lockdowns, companies who purchased oil for delivery realized they did not want the oil due to a lack of demand. This caused a massive selling of the March oil futures contracts, in favor of later-dated contracts. This caused the price structure of oil to enter into contango, in which future contracts at a later date are higher than what the spot prices are currently. This meant ETF’s tracking the price of oil would take a loss every time they rolled over to the next month’s contracts, as they mostly had to sell their futures contract at a lower price and buying the next months futures at a higher price. This also means the oil-exporting countries would be selling the next month’s barrels at a lower price each month contango was in play.

However, with OPEC forcing an extension to the cuts, they intend to force a price structure called backwardation (I don’t know why they didn’t just call it Bodango, sounds way cooler) where near-month contracts are priced higher than later month contracts. This enables Saudi and the rest of the oil-exporting countries to raise their prices and sell the next month’s barrels at a higher price.

Brent’s case for $70

As stated before, fiscal breakeven for both countries is still a far cry from what the current spot price is today. Therefore, collaboration till that price is highly likely. Iraq, a typical breaker of the OPEC quotas stated that they are “keen to adhere to the OPEC agreements and steps that lead to stability of the global markets” and that “Iraq is also fully committed to the production cut deal agreed after June and July.” With demand slowly picking up, there is a case that demand will outstrip supply, causing an unexpected jump in the price of Brent. If / when Brent reaches that price, it is uncertain whether OPEC countries will continue to work with the group’s interest in mind.

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