The oil market has been facing two, not necessarily headwinds, but sets of turbulence. On the demand side of the oil balance the running amok of the Delta variant of the coronavirus causes headaches amongst investors. In some parts of the world mobility restrictions are being lifted, but in other parts lockdowns are being re-introduced because of the spread of the disease. This certainly hinders economic growth that might have a negative impact on demand recovery.
The supply side has also been troubling because of the impasse between the UAE and Saudi Arabia on the next step of supply management. The latter hurdle was seemingly overcome yesterday after nearly two weeks of stand-off. A deal has been reached between the UAE and Saudi Arabia. An uncertainty has been ostensibly removed. Traders, nonetheless, have taken note of the UAE energy minister’s statement in which he stressed that “deliberations and consultations between concerned parties are ongoing”.
The initial market reaction was curious. Brent dropped 60 cents/bbl within seconds of the news of the agreement between the two OPEC nations only to rally more than $1/bbl in the ensuing minutes. The deal is open to interpretation just like the original disagreement was. When we cast our minds back to the end of June, we expected a rather lackadaisical OPEC+ virtual jamboree with some tapering of supply restrictions. The only question was how big the supply increase would be. When it turned out that the UAE was actually asking more than one question the market reacted with a brief rally as the Saudis made it clear that the producer group has no choice but to leave the current production level in place until the situation is resolved potentially leading to further and dangerous global stock depletion. Then concerns were raised about the UAE’s OPEC ambitions and the very existence of the organization. Fears of supply glut emerged, and bulls started to head to the exit. Nerves were somewhat calmed towards the end of last week.
Yesterday’s amicable solution to the UAE’s demand of increasing the base line from which output levels are calculated seems a healthy compromise. The Emirates base line level has been 3.168 mbpd. The UAE claims that since its production capacity is now around 4 mbpd it puts other members at a relative advantage since their reference production level is much closer to full capacity. The middle ground and the new proposed UAE base line turned out to be 3.65 mbpd effective from April 2022.
There are two aspects of the latest agreement, if it stands, that need to be looked at. The first one is how the oil balance will be affected for the rest of the 2021. Assuming that the original plan of increasing output by 400,000 bpd from August until December will be put in motion OPEC will produce 27.57 mbpd in 3Q, mbpd and 28.37 mbpd in 4Q provided that the three members with no obligation will pump 4.14 mbpd. (For the sake of simplicity, we added the non-OPEC increase to OPEC.) These figures are set against a call of 28.66 mpbd for 3Q and 29.39 mbpd for 4Q. The global deficit, therefore, will be 1.09 mbpd and 1.02 mbpd respectively but will have to be slightly modified by all likelihood when OPEC releases its latest estimates this afternoon. Of course, this scenario suggests smaller stock draws than an unchanged output level, but it is a rather supportive outcome because a.) we know what to expect and b.) global oil inventories will keep declining unabated.
The second aspect is 2022. Provided demand growth proves resilient in 1Q 2022 further easing can be anticipated. The more reassuring development, however, is that the group will keep managing the market beyond the current expiry date. This, in turn, means that the co-operation will be extended, the alliance will not fall apart, and a supply glut will have been avoided – at least this is what the current snapshot implies. Yesterday’s tentative agreement is a positive step because uncertainty has been successfully dealt with. If all members give their blessing to the latest proposal and the global economic recovery keeps supporting demand growth, then investors in oil will either be long or wrong in coming months.
Yesterday’s compromise is not a foregone conclusion -just look at the settlement prices and the continuous weakness this morning- but if we had to hazard a guess, we would be confident that it will be relied upon. The market, however, refused to take the deal for granted. After the oil complex turned briefly positive prices started to erode and when the EIA released its weekly findings on US stocks and demand an hour later than usual because of a technical glitch selling considerably intensified. Although US crude oil stocks fell for the eighth consecutive week gasoline and distillate inventories built, the former unexpectedly. The increase in product stocks was the result of refiners cutting runs by 0.4% and of declining consumption. Total product demand dived by 2.2 mbpd to 19.3 mbpd. After last week’s record consumption gasoline supply also took a breather and declined by 800,000 bpd whilst thirst for distillates moderated by 700,000 bpd.
The rise in domestic crude oil production to 11.4 mbpd did not help the bulls’ cause either and by the end of the day they were left badly bruised. WTI finished the day $2.12/bbl lower and interestingly spreads have weakened significantly. The M1/M3 price differential narrowed 24 cent/bbl on the day although Cushing oil inventories were down by 1.6 million bbls at 38.1 mbpd, 10.1 million bbls below the 5-year average. It was a disheartening ending of the day but if the original OPEC+ agreement is ultimately enshrined with the pre-conditions discussed yesterday further stock draws are almost guaranteed and what looks expensive today might look cheap come August or September and beyond.