OPEC+ once again finds itself with a difficult decision to make. A little more than a month after it eased the extraordinary production cuts put into place earlier this year, the oil market is under pressure.
Producers had hoped that they could lift output as the oil market tightened, gradually returning production to normal levels. However, the demand rebound is not materializing, at least not as quickly as OPEC+ had hoped. As the group ponders its next move, group cohesion is showing signs of fraying.
OPEC revised down its demand forecast for 2020 by 400,000 barrels per day (b/d) and by a similar amount for 2021 as well.
OPEC cuts demand forecast.
Both OPEC and the International Energy Agency released their monthly Oil Market Reports in mid-September, and both outlooks took on a more bearish tone. OPEC revised down its demand forecast for 2020 by 400,000 barrels per day (b/d) and by a similar amount for 2021 as well. The group cited slower-than-expected recovery in gasoline consumption, downside risks from Covid-19 infections, and a weaker and uncertain outlook in India in particular.
For its part, the IEA echoed that sentiment, noting the demand rebound has flattened, “and it is becoming increasingly apparent that Covid-19 will stay with us for some time.” According to the agency’s data, global oil inventories increased in July by 13.5 million barrels, bringing stocks up to record levels. After declining in June, analysts expected drawdowns to continue for the foreseeable future, so the July increase was viewed as a big disappointment and a sign of ongoing malaise in the oil market.
Brent briefly traded below $40 per barrel, and seems somewhat anchored around that level in the short run. Some of the world’s largest oil traders are now booking ships to be ready to store oil at sea, a practice seen in times of oversupply, such as in the early days of the pandemic in the first and second quarters of 2020.
Against this backdrop, the OPEC+ joint ministerial monitoring committee meets on September 17 to discuss how they will respond, if at all. In August, the group reduced the 9.7 million barrels per day Mbd of cuts to 7.7 Mbd. “After months of voluntarily renouncing additional revenue, the problems are becoming increasingly visible given the considerable financial and economic difficulties faced by the participating countries and the uncertain (demand) outlook,” Commerzbank said in a note on September 14.
Others saw a similar problem. “There were some major assumptions built in on where demand and the recovery would be now, and it just hasn’t happened,” Mohammad Darwazah, an analyst at research firm Medley Global Advisors LLC, told Bloomberg. “If I’m OPEC and if I’m Saudi Arabia, I would be concerned.”
The predicament poses new challenges to the cooperative arrangement. Compliance has mostly been high, although Iraq and Nigeria overproduced in recent months. That led to a commitment by those two countries to cut deeper in August and September in order to “compensate” for their overproduction earlier. According to OPEC’s latest report, Iraq cut output by 100,000 barrels per day in August, while most other countries raised production. The agreement for those countries to compensate bolstered the broader arrangement, demonstrating a sense of cohesion among the OPEC+ alliance and a desire to see the mission through.
With the group once again dealing with low prices and bearish momentum, there is a chance that the acrimony will return.
However, with the group once again dealing with low prices and bearish momentum, there is a chance that the acrimony will return. One area to watch is the United Arab Emirates, a producer that typically closely follows the path set by Saudi Arabia. The UAE overproduced by around 20 percent in July and August, and private sector estimates from PetroLogistics and Kpler SAS suggest the UAE is out of compliance by an even larger margin.
It’s unclear how this will be resolved; some analysts, such as RBC Capital Markets, say that Saudi Arabia will quietly pressure the UAE to fall back in line. But if the higher estimates on UAE production are accurate, then the OPEC+ group “now has a significant crisis to resolve,” Standard Chartered wrote in a note to clients.
Meanwhile, even as Iraq started to make amends by cutting deeper to compensate for earlier undercompliance, the Iraqi government is itching to produce more. The government said in early September that it may need more time to deliver on the full compensatory cuts.
The longer the market remains in the doldrums, the greater the fiscal pressure will be for OPEC+ producers. On the one hand, that raises the question about deeper cuts. On the other, individual countries are under tremendous pressure to ratchet up output to make up for lost revenues with higher volumes.
“Dark clouds are gathering once more on the oil market.”
The prospect of weakening cooperation may itself be dragging down oil prices. “Dark clouds are gathering once more on the oil market. This time, the pressure is coming from OPEC, which previously played a major part in driving up prices through its good quota discipline,” Commerzbank said in a note on September 15. “While Saudi Arabia is appealing for rigorous compliance with the quotas and is threatening rebel members with a price war, growing resentment is evident even among its traditional allies, the UAE and Kuwait.”
Put more bluntly: “OPEC will have to get its act together, otherwise this market will remain depressed,” Tamas Varga, an analyst at PVM Oil Associates Ltd, said in a Bloomberg interview.
However, returning to deeper cuts would be a heavy lift. The most likely outcome is a stay-the-course approach, along with a strongly-worded statement regarding readiness to do more, according to Citibank. On top of that, more arm twisting by laggards to get back on board and boost compliance. Despite the signs of discord, it is likely that Saudi Arabia will “save the day,” Commerzbank said.
Looking forward, most analysts still see the market tightening as we move into 2021. But the “recovery” is taking a lot longer than many expected, including that of OPEC+ producers.