“Oil prices could rocket above $100/bbl in the wake of the collapse of production talks between the OPEC+ group of oil producing countries.” (Dan Brouillette, former US energy secretary)
“The UAE has been investing heavily in its production capacity and clearly wants to put these barrels into the market. If this is the case, then all other members should be on alert for a flash flood as Saudi Arabia is likely to act to reassert its position as OPEC’s de facto leader, and prices below $40 are now a possibility. “ (JBC Energy)
The above diverging views neatly sum up the confusion and uncertainty the abandoned producer meeting caused on Monday. To understand which of the above opinions might prove accurate (incidentally, both can become reality with different time frames), it would be helpful to pin down what could have caused Tuesday’s and yesterday’s ferocious price fall. There are several plausible explanations.
After the news of no agreement broke it was announced that OPEC+ would continue with its July production level until the end of April 2022 when the pact is set to expiry. This suggested 2 mbpd of less supply by the end of the year and significant imbalance between supply and demand. Oil prices have been rising since November last year and market players might have concluded that this is as bullish as the outlook can get for now and profit-taking set in.
Or they might have thought that growing friction within the alliance is in no-one’s interest in the long-term and an agreement would be reached in the not-so-distant future. The initial rally that greeted the breakdown of talks turned into a massive long liquidation. Betting on the eventual withdrawal of the UAE from the organization and the breaking up of the producer group could have also occupied traders’ minds when the tide turned Tuesday lunchtime.
The most likely explanation, however, is uncertainty. The supply-demand outlook for the balance of the year had showed gradual drawdown in global and regional oil stocks – the OPEC+ meeting was supposed to determine the extent of this inventory fall. With the non-agreement the supply side of the oil equation has been thrown into chaos. After all the range within which the group’s output level may fluctuate is around 6 mbpd – under a free-for-all scenario production could rise above the current level by this amount. Uncertain market conditions often lead to pragmatism where investors are unwilling to take unnecessary risks until the dust settles. What we have seen the past two days has been a defensive move in the wake of the unpredictable future. The reaction of the failed meeting and the subsequent exodus from oil demonstrate the delicate balance the producer group must strike in order to ensure market players of its reliable role as the central bank of the market.
Despite the crash the price action might suggest that the bottom is not far. Genuine worries of a developing oil glut or the break-up of OPEC would lead to an ostensible weakness in price structures. It was, however, not the case. Although inter-month spreads of the international crude oil marker, Brent, has weakened somewhat yesterday, the backwardation is actually wider than it was at the end of last week. The M1/M3 price differential that settled at $1.65/bbl last Friday was 5 cents/bbl stronger by last night’s close.
This suggests that no immediate flooding of the market is anticipated and maybe attention will shift back to the here and now. When the focus will turn to the actual oil balance again the current dip might prove irresistible to buy into. Luckily, the updated Short-Term Energy Outlook from the EIA that was released yesterday is at hand to evaluate the global oil balance in the light of this week’s developments.
The first data point that is catching the eye is OPEC output estimates. The EIA is the only forecasting agency that provides projections on the groups output level, and it was revised slightly lower for the latter half of 2021. Last month it was estimated to be 28.36 mbpd but the latest report puts it at 28.25 mbpd. Of course, when uncertainty is lingering around the market it is best not to draw any premature conclusion, but it must be re-assuring for oil bulls that the EIA, for now, has not seen the need to ramp up its OPEC output estimates.
On top of the OPEC output data the global oil balance is set to be slightly more encouraging for 2H 2021 than last month. Global oil demand was left more or less unchanged whilst non-OPEC supply was amended downwards by 110,000 bpd. As a result, the call on OPEC oil that was predicted at 28.39 mbpd in June is now seen at 28.45 mbpd. OECD oil inventories are expected to fall to 2.832 billion bbls by the end of the year, quite an achievement from the end-2020 level of 3.026 billion bbls – largely thanks to the co-ordinated action of the OPEC+ group. The EIA expects Brent to average $72/bbl in the second half of the year.
There is a lot to ponder and speculate. The basic and pertinent question is whether the hard work of the last 15-18 months will fade into oblivion. Our view is that it will not. The price action of the last two days must be seen as a wakeup call by OPEC+ with no snooze button on the clock. Discord, let alone output war, within OPEC+ will not be well received by the market. In case of a protracted stand-off the biggest losers will be the member countries themselves. It is not clear how or when the current situation will be resolved therefore it is not obvious when the price recovery will begin. Perhaps, if the EIA confirms last night’s API stats, a sigh of relief will be heard from oil bulls and prices will start edging higher. It showed an 8 million bbls draw in crude and 2.7 million bbls fall in gasoline inventories. Distillate stocks built 1.1 million bbls.