Oil prices surged at the end of last week off the back of President Trump’s tweet that signalled production cuts had been agreed with Saudi Arabia and Russia. Despite the +40% move, Brent is still down 50% on the year. Longer-dated futures contracts haven’t reacted to last week’s news, suggesting there is still a huge amount of pessimism priced in owing to fundamental concerns about oversupply costs and limits to storage capacity. This has allowed the calendar spread to ease from its recent highs, which has coincided with oil-price volatility falling from historically high levels (first chart). As demand-supply imbalances resolve and the curve’s contango unwinds, this gives oil prices a platform to rise sustainably in the longer term (second chart).

Today’s oil price war has produced the sharpest drawdown in prices compared to previous wars (third chart), which may incentivise oil producers to return to the negotiating table quicker. However, oil-price wars have historically been protracted affairs, lasting at least 6 months, and today’s situation is unlikely to be resolved imminently given the failed attempt to cap US market share in 2014-16. Since then, US shale crude-oil production has rocketed, primarily driven by growth in the Permian Basin. Therefore, we expect more commitment to this game of chicken, setting a low bar for failure for Saudi-Russian production cuts to materialise.

Source: Bloomberg, Macrobond and Variant Perception