The day has arrived for the OPEC+ to make a key decision and crude oil prices could be on the verge of a big move after spending the last 6 or so days in consolidation following the big rally in November.
After cutting record amounts of oil in response to the pandemic, the cartel and allies – mainly Russia – were meant to slowly taper those cuts as prices recovered. Oil prices have indeed recovered and with the development of vaccines, normal levels of travel could resume and demand for crude oil and crude products will eventually rise back towards pre-Covid levels – if everything goes to plan.
Against this backdrop, you would think the current deal that allows some 1.9 million barrels of crude oil per day to be added to the market from January 1 makes some sense. After all, why continue to lose more market share to US shale producers, and why not sell more oil if you can?
Demand uncertainty
The trouble is, there are still lots of uncertainty in terms of when the vaccines would be delivered and how quickly people will resume normal life. The vaccines may never bring back the many jobs that have been lost to the pandemic, or the businesses that have gone bust. What’s more, the current lockdowns and restrictions could last for several months yet, possibly longer. Thus, demand for oil may remain weak longer than expected.
So, by tapering production cuts too early, the OPEC+ will risk causing an unnecessary drop in oil prices today.
Delaying the planned production increase most likely scenario
Oil ministers know too well that such mistakes in the past have caused great pain and will do their utmost to avoid making similar mistakes this time. Therefore, the most likely outcome would be to delay the planned production increase. This outcome should be supportive for oil prices, everything else being equal. Thus, in this potential scenario, Brent could go on to reach $50 a barrel after all.
However, it will all depend on what the OPEC+ will actually decide. The group will probably spend a great deal of time discussing and planning for a gradual easing of output cuts over several months. But the key question is whether the tapering would start in January or delayed to the latter parts of the first quarter, or even beyond.
OPEC+ will also want to achieve other goals
Besides the decision whether to delay January’s planned oil output increase, what the OPEC+ will also want to achieve at this meeting are: 1) an efficient output-cut-tapering strategy and 2) a more effective communication strategy with the markets. Ideally, the OPEC+ will want to taper its production cuts in 2021 and beyond in such a way that it will almost mirror the recovery in demand, and the oil producers will also want to be very transparent about their plans. That way, the episodes of big price falls or unsustainable spikes will be reduced, as the market will better anticipate the OPEC+’s future decisions.
Brent could hit $50 if tapering is slower than expected
Ahead of the OPEC+ decision, Brent oil has been consolidating its recent gains, holding comfortably above the summer highs of around $46.50 and maintaining most of November’s gains:
Today’s decision could see Brent rise to reach my main bullish objective at the psychologically-important level of $50.00, which is also where we have the 61.8% Fibonacci retracement level converging.
Conversely, if prices break lower, then watch out for signs of support around levels that were previously resistance, starting first with that high of $46.50 that was hit in August and broken in November. Below this level is the next psychologically-important level of $45 and then the old resistance-turned-support level of $43.50. Out of these potential support levels, I think $45 is where Brent will have the greatest chance of bouncing back from, in case prices drop in the aftermath of the decision by OPEC+ group today.
