The US Independence Day is usually associated with quiet trading on the international oil bourses. Not this time. Maybe the writing was already on the wall at the end of last week that the OPEC+ meeting will end without an agreement. To refresh our memory, member countries supported a production increase of 400,000 bpd between August and December this year. Yet, talks abruptly ended yesterday because of the precondition of this output increase. It was the extension of the supply agreement beyond the original expiry date of April 2022. The United Arab Emirates has proved to be the stumbling block as the Persian Gulf country objected the extension of the deadline and was seeking a higher base line for itself. No agreement was reached and as we stand now the OPEC+ alliance, if it is still the right word to describe the group, will produce at the July level for the rest of the year. The (non-) outcome of the meeting re-writes the supply-demand landscape for the near and potentially for the distant future.

  1. The balance of this year will be tight, provided OPEC+ will stick to the July output level. Adjusting yesterday’ calculation to the new situation global oil inventories should draw the 1.3 mbpd in the incumbent quarter and nearly 2 mbpd in 4Q.
  2. Global and OECD oil inventories will certainly fall below the 5-year average and oil prices are expected to increase above the often-cited $80/bbl target. This will lead to further increase in US retail gasoline prices and one can only wonder when the pain threshold of the US administration will be reached. Rising prices will also increase inflationary pressure.
  3. A new chapter might start in the Saudi-UAE relationships. The staunchest allies not so long ago, the two Middle Eastern nations have now diverging views on a number of issues: the Yemen war, the relationship with Israel or Qatar and the Saudi intention to compete with the UAE as a regional business and tourist hub.
  4. The failure to strike a deal may have sowed the seeds of another price war down the line and the existence of the 61-year-old oil cartel might be questioned.

The short-term impact is unambiguously bullish, but the question is what the market is focusing on. The view, based on yesterday’s reaction, is positive. Brent finished the day above $77/bbl for the first time since November 2018. In anticipation of tightening oil balance, the September/October spread is now flirting with the $1/bbl mark. The current snapshot implies stronger prices – it must because oil inventories will slim much faster than anticipated last week. This, in turn, could bring the price peak closer. On the other hand, it is hard to believe that the public disagreement between Saudi Arabia and the UAE will not end in a mutually amicable way. These two countries have been allies for a long time and have common political and economic interests. Both of them aim to maximize their oil revenues but clearly, they have a differing view on how to achieve that. Under this scenario, yesterday’s enthusiasm would evaporate, prices would stabilize at a slightly lower level before starting their march higher again.

Demand growth is not in jeopardy from strong dollar – for now

The recent strength in the world’s reserve currency raises the prospect of sluggish demand growth in countries that pay for their oil in dollar and, after selling the refined product, receive their revenue in domestic currency. When the cost of importing oil rises, domestic retail price increases as the greenback strengthens and sometimes this puts unbearable pressure on consumers, retail and wholesale alike. This logically leads to demand destruction. The negative dollar effect on local oil prices was put on display in the first quarter of the year when its index against six major as well as a number of emerging market currencies rose significantly. The dollar index jumped from below 90 at the beginning of January to nearly 94 three months later. Petrobras, the Brazilian national oil company, for example, was forced to increase diesel and gasoline prices at the refinery gate at the beginning of March that led to the dismissal of the company’s CEO as the government intervened to avoid the repeat of the truck drivers’ strike a month before.

The US dollar is once again flirting with the highs seen in the first quarter of the year. It means that domestic fuel priced in other than USD are increasing faster than in dollar terms. The broader picture, however, does not suggest immediate danger to oil demand growth. In fact, the price rise since the market bottomed out last April was slightly less dramatic in emerging countries than in the US. This is because despite the current resilience of the greenback it is still much weaker than it was more than a year ago. The 2019 range for the index was between 94.63 and 99.33 compared to the current value of 92.20. Brent priced in USD has nearly quadrupled in value since it fell below $20/bbl on April 21, 2020. The gains in Chinese yuan or Brazilian real were slightly lower whilst Brent priced in South African rand did not even triple in price between last April and June this year. This year’s average Brent price is still below that of 2018 and 2019 in emerging market currencies.

A protracted dollar strength coupled with prolonged oil price resilience might alter the current picture for the worse. Oil prices are unlikely to weaken significantly in the foreseeable future due to healthy demand growth and the tight supply from OPEC+. This bullish impact, however, can be mitigated by perceived weakness in the dollar. Economists, polled by Reuters, expect stable dollar in the short-term but the majority anticipates gradual weakening towards the end of the year and beyond as the global economy is cautiously opening up. The real blow for emerging markets would come if the Federal Reserve decided to raise interest rates. That move would make the dollar an attractive investment tool once again and servicing debts in developing countries would be a very tall order. US interest rates, however, are unlikely to be raised until 2023.