Oil Prices Hinge On These Two Major Events

We are just days away from two major events that could influence not just oil markets over the next few months, but also trajectory for the entire global economy.

The G20 summit is about to begin in Osaka, Japan, an event that is more often than not a rather dull affair. While the leaders involved may agree to a bland communique, the real action will be on the sidelines, with the whole world holding its breath awaiting the outcome of the Trump-Xi meeting on Saturday.

Two days later, OPEC+ will meet in Vienna. Unlike the past few meetings, all of the drama has been sucked out of the upcoming gathering. With oil demand sagging, and prices only bouncing off of year-to-date lows on the fears of a full-blown war in the Middle East, there is little room for OPEC+ countries to add supply back onto the market. Not, unless they want to crash oil prices.

On the other hand, the Trump-Xi meeting is slated to be much more dramatic. Outcomes could vary. The most positive, and perhaps least likely, is a breakthrough in the trade standoff and a removal of tariffs. Both sides declare victory, end the trade war and go home.

A sort of middle-of-the-road outcome would be for both leaders to agree to resume more robust negotiations, maintaining the current situation in the hopes of reaching a deal in a few months' time. The South China Morning Post reported that the two sides have "tentatively agreed to another truce in their trade war in order to resume talks aimed at resolving the dispute." In other words, more tariffs are put on hold, but existing tariffs remain in place.

However, the Wall Street Journal reported that Chinese President Xi Jingping may come to the meeting with a list of preconditions that need to be met for a full deal can be reached. At the same time, Xi is not expected to offer major concessions. This scenario is not necessarily incompatible with the relaunch of trade talks and maintaining the status quo on tariffs, but it does suggest that a breakthrough appears remote.

Then, of course, the worst-case scenario would be an escalation. If both sides dig in, and a mercurial Trump balks at the terms Xi brings, more tariffs could be in the offing. Trump has already threatened to put a 10 percent tariff on $300 billion worth of Chinese imports, which would sink the Chinese and perhaps the global economy. China would retaliate, although its actions probably couldn't amount to as much since its imports from the U.S. are smaller. Related: Failing Trade Talks Could Send Oil To $30

This scenario also seems less likely than an agreement to relaunch talks, if only because both sides will pay a domestic political price for escalating the trade war and dragging down the economy.

But, of course, anything is possible. "It would be unwise to be unprepared for a possible scenario where talks descend into disagreements on trade," Lukman Otunuga, research analyst at FXTM, told Reuters. "Such an outcome will most likely rattle financial markets as concerns over slowing global growth and sizzling trade tensions fuel risk aversion."

The worst-case outcome would be severely negative for the oil market. It's unclear if OPEC+ has a contingency in the works for this scenario - deeper production cuts for example. Press reports suggest that there is some agitation for something other than a simple rollover of the production cuts for another six months.

According to S&P Global Platts, Russian oil companies are itching to free themselves of the obligations of the agreement. Russian officials in recent weeks had voiced a desire to loosen the cuts. But the downturn since late May tamped down some of that restlessness. It remains to be seen whether the rally in prices over the past week has gone far enough for Russia to begin pushing for an exit.

At the same time, Algeria is reportedly pressing the group to cut deeper in order to push prices higher. Algeria has little leverage, however, and deeper cuts would disproportionately land on Saudi Arabia and its Gulf allies. Related: Oil Industry Boosts Spending… But There's A Catch

Despite the jockeying in both directions, a simple extension remains the most likely outcome, according to several analysts. "Further cuts will likely be discussed but are unlikely to be adopted," said Shin Kim, S&P Global Platts Analytics' head of supply and production. "Russia is satisfied with $60-65/b oil and is unlikely to agree to further cuts given oil producer company resistance."

The extension of the production cuts is a "virtual lock," analysts at the Center for Strategic & International Studies said. S&P Global Platts even said that when Saudi crown prince Mohammed bin Salman meets with Vladimir Putin in Japan, the two could announce a deal on oil production.

Finally, in the days and weeks following both the Trump-Xi summit and the OPEC+ meeting, the U.S. Federal Reserve could decide to take action to loosen monetary policy. The Fed left the door open to a rate cut as soon as July, although much depends on what happens on the trade front. A breakdown in talks and higher tariffs would significantly increase the odds of Fed action, which could lessen the downdraft, although, as always, much remains to be seen. 

By Nick Cunningham of Oilprice.com

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