Oil: Will the supply cuts become a chicken game?

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Julius Baer Research | Oil’s push above USD 58 per barrel on the first trading day of the year seemingly only was a temporary burst of energy. The market’s focus is on quota compliance as the oil producers must now walk the talk of supply cuts. We remain sceptical that the supply deal will have a material impact, swiftly erase surplus supplies and provide lasting support to prices. The deal partially undoes the overproduction by the Middle East and Russia which had ramped volumes towards the end of the year.

Quota compliance historically was poor and this time should not be different, not least as significant suppliers with a near term growth agenda such as Libya or Nigeria are exempt. While Saudi Arabia already announced lower output volumes, Libya’s export resumptions, Iran’s oil storage clearance sales and the ambiguous statements from Russian oil companies sow the seeds for a chicken game. Game theory economists likely are monitoring the oil market more closely these days. Last but not least, the reviving shale boom will partially offset the oil producers’ efforts. Friday’s data not only showed a further uptick active drilling rigs but also job increases in the oil and gas sector.

The bullish positioning by hedge funds in the futures market suggests that prices reflect a fair amount of optimism and are partially at risk from profit taking. Oil is in focus with the producers now acting on the pledged supply cuts. Quota compliance is game theory and the historic odds are poor. We remain sceptical the deal will swiftly eras surplus supplies.