The Fuse

Oil Hits New High as OPEC+ Refrains From Larger Production Increase

by Nick Cunningham | October 06, 2021

At the latest meeting, OPEC+ decided to add another 400,000 barrels of oil production per day in November, without much disagreement or discord.

The addition is in line with a stay-the-course approach to lifting the pandemic-related production cuts. But the group rejected calls for even more production, helping to push oil prices to their highest levels in seven years.

OPEC+’s incremental approach

Unlike in prior rounds of discussion, the latest OPEC+ negotiation went off with little fanfare. The short meeting and the decision to add 400,000 barrels per day mostly met expectations, although the recent surge in prices – and a more pronounced global spike in natural gas and coal prices – fed speculation that the cartel might consider an 800,000-barrel-per-day increase in order to satisfy growing fears of shortages.

The decision to refrain from a larger increase pushed crude oil prices up to their highest levels since the 2014 meltdown. “The confirmation that OPEC+ would keep a cap on supply, instead of feeding the market with even more product and bringing it towards a closer equilibrium, drove traders into a buying frenzy for front-month Brent contracts, as the decision guarantees a tight supply picture in November and December,” Louise Dickson, senior oil markets analyst at Rystad Energy, said in a statement.

The new highs added to a broad worldwide commodity price spike, with record electricity prices and an energy crunch sending a jolt through Europe and Asia, and to a lesser extent North America.

“Prices are likely to remain elevated for longer.”

Perhaps OPEC+ countries are rather content to let prices continue to rise. “Ministers have not challenged a market narrative that assumes tight balances and an associated lack of spare capacity; as a result, prices are likely to remain elevated for longer,” Standard Chartered wrote in a note. “The implication that OPEC+ is not yet overly concerned about negative demand effects also suggests to us that it will defend a higher price floor than we previously thought.”

The bank added that OPEC+’s decision not to hold a press conference or even offer any insight into oil market fundamentals, as is typical, suggested that the group was “perhaps a little embarrassed by the situation,” and didn’t want to talk about the impacts of high prices on consumers around the world.

The flip side is that there tends to be a bit of inertia around sticking with a particular pathway. Any changes to the production cuts can open up “a Pandora’s box of complications,” Standard Chartered said. Member countries are reluctant to change course as it can contribute to cheating and jockeying for special treatment.

There are also other narratives put forward by varying analysts that raise the possibility that OPEC+ may not want to add additional supply onto a market that actually looks weaker than conventional wisdom believes. This theory took on more credence when Saudi Arabia decided on October 5 to cut prices for its crude shipments to Asia by 40 cents per barrel for November, a signal that demand might be a bit tepid. The global rally for commodities may also cool demand as consumers cut back.

Either way, OPEC+ will likely wait until the regular meeting in December to take a more decisive step.

Another problem (and bullish factor) is that some OPEC+ countries – such as Angola, Venezuela, and Nigeria – are unable to increase their production even if they wanted to. In August, the group as a whole produced 860,000 barrels per day below the production quota, according to the International Energy Agency.

If production continues to lag behind the stated target, then “further price rises can be expected,” Commerzbank said in a note to clients.

Supply stuck

Oil prices are now at multi-year highs, and in a previous era that would have sparked a drilling boom. But while the rig count in the U.S. shale patch ticks up a bit with each passing week, it remains a fraction of its former self. And capital expenditures from oil and gas companies remains subdued.

Investors simply are not interested in bankrolling more drilling. Part of the problem is the decade of losses from shale drilling and miserable financial returns for much of the industry. Another factor preventing new drilling is the prospect of energy transition, which is accelerating.

Investors are not willing to put huge sums on the line for an industry that is facing decline.

Investors are not willing to put huge sums on the line for an industry that is facing decline. This logic leads some, such as analysts at Goldman Sachs and Bank of America, to predict triple-digit oil prices.

But as the transition picks up pace, feedback loops can work to push it further along. Capital shifting from fossil fuels to clean energy is an example of one of those feedback loops that could reinforce the energy transition, increasing the cost of capital for new fossil fuel projects.

In any event, shale companies do not appear willing to drill aggressively again, despite near-$80 oil. “All the shareholders that I’ve talked to said that if anybody goes back to growth, they will punish those companies,” Pioneer Natural Resources CEO Scott Sheffield told the Financial Times. He added: “I don’t think the world can rely much on US shale…It’s really under Opec control.”