OPEC and allies likely to raise output

Crude oil futures rallied in the Asian session before paring gains as the European session progressed as traders look ahead to the OPEC+ meeting this week. OPEC and allies meeting is scheduled on 4th March 2021 with market participants looking at likely easing of output constraints.

Going into the meeting, analysts note that global inventories are falling at their fastest rate in two decades. Clearly with the ongoing demand uncertainty there is a risk that OPEC over tightens by maintaining output curbs for too long. The risk is now one of keeping too much oil on the side lines and not pumping enough, which will drive prices sharply higher. Goldman Sachs says Brent will hit US$75 this year.

Thirteen OPEC members pumped 24.89 million barrels per day (bpd) during February 2021, down 870,000 bpd from January 2021 in the first monthly decline since June 2020. In February the largest supply cut came from Saudi Arabia, which pledged an additional, voluntary one million bpd production cut for February and March. As a result, compliance with pledged cuts stood at 121% in February, up from 103% in January.

Current output constraints stand at a little over 7 million bpd, with the 23-country OPEC+ likely to agree to reduce this by another 500,000 bpd from April on Thursday. In addition, it’s likely Saudi Arabia will confirm the additional one million bpd it removed from the market will return in April. This would bring an additional 1.5 million bpd on stream, but even this may not be enough to satisfy the demand. 

OPEC will be mindful of the IEA report that suggested that inventories could start to climb again in the second quarter due to seasonal factors before drawing down again in the second half of the year.

“The rebalancing of the oil market remains fragile in the early part of 2021 as measures to contain the spread of COVID-19, with its more contagious variants, weigh heavily on the near-term recovery in global oil demand,” the IEA’s latest Oil Market Report said.

“But fresh support has been provided by a more positive economic outlook for the second half of the year, along with a pledge from OPEC+ to hasten the drawdown of surplus oil inventories.” The report added

The spread on Brent futures contracts points to significant short-term supply shortage. Six-month spreads are above US$3, while the December contract trades about US$4 below the May contract as the front months are commanding a significant premium over back months, a situation known as backwardation. This implies bullish positioning and tight supplies. Analysts also see similar levels of backwardation on WTI futures, with the April contract trading about US$4 above December contract.

OPEC should be mindful of US shale producers, albeit the conditions for a sharp recovery in output are not what they once were. Nevertheless, OPEC+ could, by keeping output too tight, create conditions for a sharp acceleration in prices that see rivals deliver more. 

Baker Hughes said oil and gas producers added rigs for a 7th straight month for the first time since May 2018, although the rate of growth slowed as the Texas deep freeze hit. The less OPEC does to return the production cut last year the quicker these numbers should rise.

Has Saudi Arabia accepted its oil policy was faulty?

Saudi Arabia leading the oil cartel, Organization of the Petroleum Exporting Countries (OPEC) has surprised oil traders and analysts by announcing a production deal at the end of a recent but informal meeting in Algiers. This is after a long time that Saudi Arabia has consented to production cut. In 2014, against all odds Saudi Arabia had decided to enhance output for retaining its market share.

At Algiers, OPEC members committed themselves to an overall output level. The cartel issued a statement comprising of less than 700 words, out of these the two most important announcements were: 1) commitment by 14-member cartel to fix a maximum ceiling of 33 million barrels daily out (bpd) and 2) announcement to establish a committee to study the implementation of fixing new production levels for individual member countries and to consult with non-OPEC oil producing countries.

The critical question remains whether the production target will affect the actual number of barrels being marketed by the organization's members?

In response to the OPEC decision, oil prices settled mixed on Friday while posting their second straight monthly gain. While skepticism prevailed about the cartel's pledge, some analysts believed that the global oversupply at the maximum is around 1.5 million bpd. This can be managed easily if every member acts prudently. Saudi Arabia has the highest responsibility to set precedence by cutting its output up to 750,000 bdp and also to reap the highest benefits. Some analysts believe that Saudis probably calculated that an increase in prices to $50-60 per barrel would bring useful extra revenue to them without stimulating too much production from other sources due to some prevailing constraints.

If one looks at OPEC's latest production figure, it prompts even bigger cut. They are all Petro states suffering from low oil prices. It is prudent for them to cut production a little voluntarily and get a meaningful increase in their revenue. The mere announcement about production cut has raised oil price by more than 5 percent and actual cut could bring even higher gains.

Russia, one of the arch rival of Saudi Arabia in geopolitical arena, has been producing/pumping crude at record highs, said it would find a way to freeze production if a deal is reached with OPEC. The US ‑ present foe but a friend of yester years, also a non-OPEC member and now the biggest oil producer ‑ said on Thursday it had little faith in the OPEC plan. U.S. energy envoy Amos Hochstein told Reuters that any price gains from the cuts would trigger higher U.S. production, which would ultimately defeat the deal. This is a real treat as a weekly report about U.S. oil rig count showed local drillers have added 95 rigs for the third quarter, the most in any quarter since 2014.

Within OPEC and besides Saudi Arabia, supply has risen since 2014 as OPEC relinquished its historic role of fixing output to prop up prices as Saudi Arabia, Iraq and Iran wanted to pump more oil.  Supply from Iran, another arch rival of Saudi Arabia has posted the fastest increase in exports after the lifting of Western sanctions. Its production is inching towards the pre-sanctions levels.

The kingdom’s change of heart seems to have come from a realization that low oil prices were not rebalancing the market in the way that official hoped. Lower prices were expected to curb production by other producers with higher costs while improving the kingdom’s long-term position. Shale production in the US has been falling since early 2015 but it has been more than offset by increasing output from OPEC members.

The kingdom’s strategy assumed that it had sufficient financial resources to withstand a prolonged period of low prices while competitors would be forced to scale back. But the downturn in oil prices has lasted much longer than and shows no sign of ending. Falling oil revenues have pushed the kingdom’s economy close to or into recession and forcing deep cuts in government spending on infrastructure as well as social payments and salaries. Saudi Arabia’s foreign reserves have declined by $182 billion, a fall of nearly 25 percent, since August 2014

The decision certainly shows a strategic shift at the top of the Saudi administration, where Deputy Crown Prince Mohammed bin Salman has emerged as the key decision-maker. Prince Mohammed indicated earlier this year, it would not matter for the kingdom whether oil prices were $30 or $70 per barrel. But in recent months officials have realized that prices are unsustainably low and want them to rise.

Moral of the story is that Saudi policymakers are making another big assumption that rival producers have little capacity to raise output in the short term. They may be partly right because Iran is close to its pre-sanctions production capacity and will need significant investment to achieve substantial increases in output. Russia too probably has limited ability to increase production in the short term.

However, the key threat that remains is a potential increase in shale production in the meantime. U.S. shale companies have already added more than 100 drilling rigs since the end of May, despite the fact that the sector remains under intense financial pressure.

Winners and losers of oil war

The US and Saudi Arabia will never accept that they are entwined in an apparent oil war. While Saudi Arabia keeps on producing oil at record level to maintain its share in the global markets, its earnings are plunging. Despite decline in price the shale oil production has not seen any significant reduction, although number of active rigs have declined to blow 600 from above 1,600.

On the face it appears that the US and Saudi Arabia are fighting ‘price war’, the perception is negated because both the countries connived to take the price above USS147/barrel. They are still supporting each other to punish Russia and Iran.

Oil from many countries is being pilfered by ISIS, which is being bought by those who claim to be fighting a war with the most brutal outfit, drawing strength from selling pilfered oil. In a way Kurds also don’t have the ownership of oil which they are exporting from Iraq.

Countries called P5+1 agreed with Iran to remove sanctions, but the restrictions still continue. Iran has borne the brunt most, because its oil related revenue has nearly halved and it is not yet clear when will it get the chance to boost oil exports.

Initially, Saudi Arabia was not willing to curtail daily production by OPEC members, but now it is talking about containing production provided Russia and other non-OPEC members also agree to curtail output.

With winter approaching fast, consumption of heating oil and gas is expected to rise but stockpiles are still hovering at record levels.

It may be true that all eyed are fixed on 4^th December meeting of oil cartel but little is expected to change. The three giants, the US, Saudi Arabia and Russia are not likely to change their stance.

The credible signs of improvement in the US economy are missing, Chinese economy is still faltering and IMF has already curtailed rate of global economic growth.

One point is clear that oil demand is not likely to grow significantly in the near future. Therefore, the only option available to oil producing countries is to curtail production. Many analysts are of the view that December 4 will come and go but the glut will continue.

Let no one forget that the biggest beneficiary of declining oil prices are OECD, are they ready to take a hit? The reply is a loud NO!