Oil Production - OPEC: What to Do and the What-ifs Regarding the Vaccine
By: Johan Rosenberg, Chairman
The weekend's OPEC meeting ended without an agreement among its key members - Russia (increase production in January), Saudi Arabia (extend production cuts 3-6 months), and the UAE (okay with production cuts, but only if all OPEC members comply with the cuts).
Oil will begin piling up in storage tanks at the key U.S. hub of Cushing, Oklahoma, if OPEC restores production to 2 million barrels a day starting in January. The market would struggle with this oversupply. However, if OPEC keeps or extends production cuts, U.S. and other non-OPEC producers will likely increase production and capture market share.
Prices of $40 per barrel results in break-even profitability for U.S. producers. Anything above $40 produces surplus cashflow, and a drop below $40 results in U.S. producers being unprofitable.
One must evaluate potential oil production levels with the following “what-ifs” in mind: What if expectations fade for the efficacy of the COVID-19 vaccine? What if the virus is better at evolving resistance to the newly developed vaccines? What if COVID-19, when compared with HIV, changes slower as it spreads? What if as population-wide immunity grows, through infection or vaccination, immune-evading mutations help COVID-19 persist through 2021, and perhaps even longer? What if the virus mutates like HIV did and evades the many vaccines and treatments developed to combat it? I hope none of these “what-ifs" come to fruition. But I think as a layman in microbiology, there is some clear probability some or all of these scenarios could happen.
With a third, fourth or even fifth surge - a 3-month production cut extension wouldn’t be enough to support prices with extended restrictions. This could send Brent Crude back down to $40 per barrel, or lower. A 6-month production cut extension, and a successful deployment of the vaccine during the winter months, would deplete the oil storage overhang and supercharge prices into the mid-$50s.
Bottomline, keep an eye on oil futures as COVID-19 continues to deliver uncertainty during the winter, but remember our jubilance as we came out of lockdown this past spring. Recall talk of economic recovery with increased demand for transportation, growing factory backorders, etc. Irrespective of the course of the pandemic, Chauncey Gardiner perhaps said it best: “In a garden, growth has its season. There is spring and summer, but there is also fall and winter. And then spring and summer again…” This statement is a simple, but powerfully true economic theory. Keep it in mind and be optimistic for the latter half of 2021 and for increasing prices of oil.
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