Raising Price, Cutting Output: Mixed Signals from Saudi Arabia

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Saudi Arabia underpinned oil mood on Monday announcing additional output cut by 1 million bpd. starting in June. The Kingdom’s output is expected to decline to 7.5 million bpd., the lowest level for almost 20 years. The underlying motive is probably to speed up market rebalancing and hence price recovery. It is worth mentioning that the decision of the Kingdom soon followed the telephone conversation of Trump and the King of Saudi Arabia. Brent jumped 5% on good news, but the bullish momentum proved to be short-lived as the price closed below the opening. Given the news that Saudi Arabia decided to rise OSP for June, the extra cut may seem as a weird move since by cutting output producer signals about expectations of declining demand, while charging higher prices is usually a sign of improving demand picture.

The Kingdom has successfully passed the baton of additional voluntary production cuts to other Middle Eastern countries, in particular Kuwait and the UAE which decided to follow suit and said they will reduce output by 100 and 80 thousand bpd in June, respectively. There is an aspect of the OPEC+ deal which explains limited optimism about the news: uncertainty in commitment of the individual participants to output cut targets. In other words, these additional output cuts may either surprise to the upside later, signaling about over-fulfillment of the plan or play out as a downside surprise if subsequent data reveals poor performance of other participants. For example, Iraq has historically turned out to be the least “diligent” member of the cartel (in terms of following a collective agreement), so there are concerns that the country won’t be able to deliver the output cut by 1 million b/d.

Today we expect the report from US Department of Energy (EIA), which will contain a short-term outlook for the oil market. It will be interesting to see how the agency adjusted their projections considering recent changes such as collapse of drilling activity and fairly rapid decline of the US production over the past few weeks. OPEC is going to release its monthly report on Wednesday and on Thursday the monthly EIA report is due which is of particular interest because of extremely vague demand picture and lack of reliable estimates of demand recovery.

The Chinese statistical agency reported that annual inflation in April was 3.3%, which is less than the forecast of 3.7%.

But looking under the hood we don’t see signs of severe slack in consumption: decelerating food inflation accounted for a good part of the slowdown in the aggregate indicator. Core inflation which excludes volatile components such as good and fuel was up 1.1% in annual terms. At the same time, production price index indicated a deflation of 3.1% against the forecast of -2.6%. Given the reliance of manufacturing sector to foreign demand, PPI points to weakness in foreign economies.

Easing inflation pressures gives a firm nudge to the Central Bank to proceed with a new round of monetary easing, which should bring some relief for local and foreign risk assets. The quarterly PBOC monetary policy report released over the weekend indicated a growing bias of the Central Bank to strengthen liquidity support for the economy in the near future.

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