▪ The Kingdom of Saudi Arabia announced on Monday that it will be cutting its oil
production by another 1 MN BPD for Jun’20, on top of the already agreed upon ~2.5
MN BPD cut announced as a part of the OPEC+ agreement in April (effective May’20).

▪ Following the cut, the production rate from Saudi Arabia is expected to be ~7.5 MN
BPD, 4.8 MN BPD lower than Apr’20’s production.

▪ Kuwait has followed suit and announced an 80,000 BPD cut in its production in June
this year. The United Arab Emirates (UAE) has also pledged to reduce its production
by 100,000 BPD in June.

▪ The market did not respond as anticipated to the news, with WTI and Brent futures
trading down by as much as 5% soon after the announcement yesterday; likely driven
by expectations of lower crude oil demand spilling into June painting a rather bleak
picture. However, some strength is seen in the commodity’s prices today.

▪ To recall, OPEC+ countries had agreed to cut production rate by 9.7MN BPD, or 22%,
in a bid to avoid a supply glut in a market plagued by lower demand as the COVID-19
pandemic limits transportation and industrial activity across the globe (Annexure A:
Production Cut by Country).

Understanding the move and the timing from Saudi Arabia:

▪ Saudi Arabia on Monday also announced that it would be taking fiscal steps to aid the
distressed economy. The fiscal steps include: a) tripling of value added tax rate from
the current 5% to 15%; and b) suspension of cost of living allowance for government
employees.

▪ According to official statements from Saudi Arabia, the move to cut the country’s
production rate is geared towards a “lead by example” approach, encouraging
adherence to agreed-upon production cuts by other OPEC+ member countries.

Demand outlook still not great…
▪ Oil traders had opined that restrictions on travel and economic activity around the
globe could see demand destruction of as much as 30 MN BPD. OPEC’s Monthly Oil
Market Report for Apr’20 highlighted that world demand would be down by 12 MN
BPD in 2Q of the calendar year.

▪ According to a recent statement from UAE-based airline, Emirates, the subdued
demand for aviation is expected to last for the next 18 months. Similar expectations
are coming from the aircraft-manufacturer, Boeing, which has recently laid off 10% of
its total workforce.

…But supply-side dynamics to buoy the market into equilibrium

▪ According to data from Baker Hughes, 915 rigs were operational around the world at
the end of Apr’20, 14% lower than the earlier month and the same period last year
(Annexure C: International Rig Count).

▪ As for North America, there were 400 operational rigs in the region as of May 8, 2020,
compared to 435 in the earlier week and 1,051 in the same period last year (Annexure
B: North American Rig Count).

▪ The effects can be seen culminating into the United States’ production rates, which,
according to the Energy Information Administration (EIA), stood at 11.9 MN BPD on
May 1, 2020, compared to 13.1 MN BPD on February 28, 2020. Crude oil stocks in the country increased to 532.2 MN BBLs as of May 1, 2020, compared to 527.6 MN BBLs in the earlier week.

▪Bloomberg data suggests that 165 MN BBLs of crude oil was held in floating storages as of May 8, 2020, 7% higher than the earlier week. To recall, a shortage of storage had led to WTI futures contracts trading into the negative in April this year. (Annexure D: Global Floating Storages vs. Crude Prices)

Crude oil outlook:
▪ In our view, due to supply curtailments around the world, along with lockdowns being eased and economic activity picking up once again, commodity’s prices are expected to find support. As a result, we envisage Arab Light averaging USD 18/BBL in Jun’20 quarter, following which a reversion to USD 30/BBL is projected for 1HFY21 and USD 45/BBL thereon.

▪ With the assumptions, we believe that Oil & Gas Exploration stocks are trading at attractive levels, with OGDC and PPL being our top picks. The stocks are trading at substantial discounts to their 2-Yr. P/E Avg. and the average P/E during the crude oil price slump earlier witnessed in 2015-16—as illustrated in the table below.