Oil bulls are all smiles, having achieved the seemingly impossible: Not a single additional barrel of output was agreed by OPEC+ for August onward.
The truth is, trouble may just be starting for longs in the market.
After two days of unyielding talks between Saudi Arabia and the United Arab Emirates, OPEC+ decided it was best for the two former staunch allies—and now somewhat rivals—to discontinue negotiations over next month’s export quotas.
There was no official communique to the effect from the 23-nation OPEC+, which groups the 13 original members of the Saudi-led Organization of the Petroleum Exporting Countries and their 10 allies steered by Russia.
Those with knowledge of the matter, however, told the media that in the absence of an agreement for August quotas, the cartel’s current production limits will remain in place.
OPEC+ was supposed to have agreed on a production hike of at least 400,000 barrels per day for next month. Oil markets spiked on the news as depriving the global economy of vital extra supplies amid the recovery from the coronavirus pandemic was interpreted as super bullish for crude prices.
Global crude benchmark Brent soared in Monday’s London trade to above $77 a barrel, a level not reached since October 2018.
New York-based West Texas Intermediate crude, doing limited trading on Monday due to the US Independence Day holiday, caught up with the gap left by Brent in Tuesday’s Asian session, hitting an intraday peak just shy of its October 2018 peak of $76.90.
Year-to-date, Brent is up almost 50% and WTI 58% from the daily strangulation of crude supply carried out by OPEC+. The alliance is still withholding around 5.8 million barrels per day of the group’s proven production capacity from the market, versus cuts that originally began at 10 million in April 2020.
Oil bulls are now salivating at the prospects of Brent reaching $80 in a matter of days, as Goldman Sachs prophesied months back, and perhaps even the $100 that Bank of America recently forecast.
That is based on the hypothesis that the OPEC+ unity to comply with cuts laid out by the Saudi-Russian hegemony that controlled the alliance remains intact.
With The Saudi-UAE Spat, Will The Rest Of OPEC+ Honor Cuts Like Before?
As proven over the weekend, the unity within the alliance has started fraying and may only deteriorate from here.
Bloomberg noted in a report on Monday that the failure to agree on new quotas for August was “a significant failure for the cartel,” adding:
“Relations have soured between two core members of the Organization of Petroleum Exporting Countries to such an extent that no compromise was possible. It damages the group’s self-image as a responsible steward of the oil market, raising the likelihood of a further inflationary price spike.”
The oil market should also look out for something else: Deterioration in OPEC+ compliance to cuts hereon in, as ‘habitual cheaters' in the alliance up their game.
For instance, the Russians, who share stewardship of the group with the Saudis, are notorious for dishonoring their own export quotas, never mind having to enforce the cuts of others.
While other legacy cheats such as Nigeria and Iraq have been more or less keeping to their production limits lately, the UAE’s visible rancor with Riyadh could embolden them to overstep boundaries.
As of end-May, OPEC+ compliance to cuts reached a historic 122%. It must be noted that the over-delivery was mainly because of one source—Saudi Arabia itself.
Therein, lies the crux of the problem between the Saudis and the Emiratis. As the one typically doing the heavy lifting on cuts, even way back in 2016 when the first OPEC+ agreement was forged, the Saudis feel entitled to earn some additional revenue at these prices by easing more of their reductions and less of the others.
Under Riyadh’s plan, OPEC+ is to raise output in stages by about 2 million barrels daily from August to December and extend cuts to the end of next year instead of April 2022, without an adjustment to baseline production levels.
The Emiratis, however, are upset about the baseline from which their production cuts are calculated, arguing what they agreed to was too low at the height of the pandemic. Abu Dhabi has invested billions of dollars since to increase its production capacity and wants to pump more to make good on that money.
UAE oil production hit a record of more than 4 million barrels a day in April last year during a brief supply war between Saudi Arabia and Russia. Prior to that, the country had only ever pumped more than 3.2 million barrels a day for a whole month twice—in November and December 2018.
To be sure, on their own, the Emiratis will never be able to pump enough to flood the oil market and sink prices. But the fight they put up against the Saudis might just embolden others in the alliance to release more barrels.
There are other developments to watch as well.
The Iran Deal, US Production
In the periphery of the OPEC issue is a potential nuclear deal for Iran with world powers. While that does not appear imminent, its timing could still surprise. If such a deal happens, US sanctions on Iranian oil exports will end, potentially returning 500,000 barrels per day to that market immediately or as much as 2 million per day over the longer term.
Iran is a founding member of OPEC, but due to the sanctions is treated like an outcast within the cartel—particularly by long-time enemy Saudi Arabia. While Tehran hasn’t contributed a single barrel to the Saudi-ordained cuts, its legitimate return to the market will bring some pressure at least on crude prices.
There’s also the question of US production, which has been a rather tame 11 million barrels daily for months on end, after collapsing from a world high of 13.1 million just before the outbreak of the pandemic in March 2020.
The US oil rig count, an indicator of future production, has been growing at a snail’s pace despite the explosive prices for crude, as the Biden administration’s pro-renewables energy policy discourages environmentally-unfriendly fossil fuels. US energy firms also routinely get punished with lower stock prices by investors whenever they announce any plan to get aggressive with drilling.
Still, in a slight change of tone, the Biden administration expressed its wish on Monday to see more oil on the market via an OPEC+ deal. In a statement directed at the alliance, the White House said:
"We are not a party to these talks, but administration officials have been engaged with relevant capitals to urge a compromise solution that will allow proposed production increases to move forward."
The statement came on the heels of Friday’s regular White House media briefing, where Press Secretary Jen Psaki voiced concerns about the impact of rising oil prices on American consumers.
The remarks were the first of their kind from the administration since it came to office in January, signaling it was finally awakening to inflation concerns and the impact of the increasing oil price, as gasoline prices at pumps hit new seven-year highs above $3 per gallon.
To sum up, the upside risk to oil prices is still greater now than the downside. Yet, don’t be surprised if the market consolidation/correction sets in faster than thought, despite the OPEC hype of no cuts.