BETA
This is a BETA experience. You may opt-out by clicking here

More From Forbes

Edit Story

OPEC+ Impasse Sets Oil On Unpredictable Course

Following
This article is more than 2 years old.

What is to be expected for oil prices after OPEC+ cancelled talks on increasing production in the coming months?

The situation may not be as bullish as many think.

Crude benchmarks Brent and West Texas Intermediate (WTI) immediately rallied on the news that OPEC+ ministers called off discussions on Monday after being unable to reach a compromise with the United Arab Emirates (UAE), which wanted the parameters of the agreement changed so it could pump more oil. 

Brent has pushed up as high as $77.66 a barrel — the highest level since October 2018 — and WTI to its highest since late 2014 at $76.90 a barrel. Oil is up about 50 percent this year and over 385 percent since last year’s Covid-19 collapse. 

With no new date set for the next OPEC+ meeting, markets are left guessing about the future of the cartel’s supply management deal. 

Taken at face value, the breakdown in the talks looks bullish for prices, since it means that the current OPEC+ output restrictions will remain in place, rather than the extra 2 million barrels a day that the group had proposed to add from August to December

That rationale certainly makes sense. Indeed, without the infusion of some additional barrels of oil in the coming weeks, Brent could pass the $80 threshold, given the tightness of the market and continued recovery in global demand from the pandemic. 

But a deeper look suggests the latest OPEC+ drama probably creates a more bearish outlook for oil prices. 

Why? Because it represents another serious challenge to the cartel’s cohesion. 

The most bearish outcome would be the total collapse of OPEC+ and each member producing as much crude as they want, sparking a price war like the one we saw in March 2020 after Russia failed to agree to new OPEC+ supply cuts proposed by Saudi Arabia. Such a result would see supply greatly exceed the most optimistic post-Covid demand forecast because OPEC+ is sitting on about 9 million barrels a day of spare capacity — or nearly the equivalent of 10% of global demand. 

That scenario is unlikely to happen. Producers remember the financial pain inflicted by last year’s price war and know that this is not in their best interests, particularly now that the positions of Saudi Arabia and Russia — the leaders of OPEC+ — are aligned. Riyadh and Moscow are both poised to increase OPEC+ supply from August to December at a rate of around 400,000 barrels a day per month and extend the cartel’s supply management duties beyond the current deal’s expiration on April 1, 2021.

With the group leaders committed, the most likely outcome is that the UAE will come around in the coming weeks after some compromise on its production quota. 

But a compromise is likely to have bearish consequences for prices.  

At issue for the UAE is the baseline production figure used to establish its supply cut. It wants this figure increased by around 700,000 barrels a day because it believes that its sacrifice — leaving about 30% of its production capacity idle — has been greater than the sacrifices made by other OPEC+ members. 

The UAE is not budging on this issue. It refuses to sign up for another OPEC+ agreement beyond the current one unless the matter is rectified. 

Any reassessment of OPEC+ production baselines will invariably result in higher group production. Other OPEC+ members, including Iraq and Kazakhstan, also reportedly would like their quota baselines adjusted so that they can produce more. So OPEC+ would be opening a can of worms if it goes ahead with the exercise of setting new baselines. 

It’s also possible that OPEC+ tries to diffuse the situation by suggesting the UAE could cheat a bit on its current quota. That would put more oil on the market and could encourage weaker compliance from other members. 

Either outcome, combined with a likely return of Iranian barrels to the market as Washington and Tehran move closer to a nuclear deal, would deal a blow to oil prices. 

Regardless, when there are problems inside OPEC+, it generally darkens the medium- and long-term outlook for oil prices. Everyone knows that the OPEC+ experiment won’t last forever, and events that may accelerate its demise are unequivocally bearish. 

The UAE, which is investing to increase its oil production capacity by 1 million barrels a day to 5 million barrels a day by 2030, has been considering whether it still makes sense to remain in OPEC, so this rebellion should come as no surprise. 

And while it probably doesn’t make sense for it to leave OPEC just yet, it’s clear the UAE is getting ready for the eventual battle for market share as the date for peak oil demand gets closer. No producer wants to leave assets stranded. 

The sell-off in crude on Tuesday reflects some of these concerns, as evidenced by Brent and WTI being back to the $75 and $74 levels. 

To be sure, oil demand and the strength and pace of the post-Covid economic recovery will go far in dictating the direction of prices. But this market still needs supply management, just as it did before the pandemic struck. 

If nothing else, the events of recent days show that U.S. shale producers have been correct in maintaining capital discipline and not chasing higher prices by investing more in new drilling. The downside risk is simply too high with so much OPEC+ spare capacity sitting idle. 

Make no mistake, the oil market is heading toward a deeper supply deficit in the coming weeks and months as demand continues to recover. But oil will be on a wild ride until OPEC+ agrees to some concrete supply policy. If traders were expecting a calm July, they now must sit tight as the market’s unpredictability can cause major tremors.

Follow me on Twitter or LinkedInCheck out my website or some of my other work here