OPEC+: Cohesion harder, as fundamentals tighten

In early July 2021, OPEC+ faced several public challenges to its medium-term supply outlook as it looked to extend its production agreement and allow for a long awaited increase in oil production. On the July 1 meeting the UAE blocked agreement of the near-term agreement (production increases through year end and commitment to current levels until end 2022) as it wanted to reset its capacity. The UAE is one of the a few countries looking to reset market share – and one of the few that is pushing for that reset and could deliver in the near term (Iran and Iraq are more interested in future potential). It is also one of few (along with Saudi Arabia) that has consistently over complied with OPEC+ agreements and is sees this as an opportunity for a reset… and ensuring that lower financial and carbon energy supplies maintain/increase market share. See my recent piece in the interpreter for more on the divides within OPEC and my recent comments to Platts on the on-hold Iran deal.

At time of writing there were talks about a face saving solution, though this has yet to be confirmed. After its standoff at the beginning of the month OPEC seems to be getting closer to a deal on a production increase and partial resetting of market share. The deal, as yet unconfirmed, would allow a planned 400K/m barrel increase and a reset of production targets for the UAE and perhaps some others starting from next spring. This agreement if it holds would help maintain OPEC market share and help redistribute it to countries that can produce more, aiming to limit the increase in production from more market driven producers like the US and Canada. 

The standoff reflected a divergence within oil producers in the face of the global uneven reopening/recovery between those countries with lower fiscal costs who are more comfortable with  lower price/higher volume like UAE and Russia and those which struggle to add production like Nigeria. The proliferation of net zero targets and investment goals has increased urgency to covert energy assets into financial ones, to support domestic growth… and to make sure that lower cost/lower emissions production take a larger slice, not more financially and carbon costly production in the US, Canada and Brazil to name a few. 

Global oil demand has revived significantly as lockdowns ceased and people avoided public transport – increasing the carbon intensity of growth/transportation – in other words an oil-fueled recovery as plastics and higher emissions products dominated despite net zero targets. The next oil forecasts out from OPEC today showed continued if more moderate increases in 2022, and support OPEC’s more conservative stance

 Global demand is still below the 2019 recent peak due to the decline in international air travel and lower industrial demand in some countries like India, but other demand changes have stabilized. Key to the outlook is a view that lockdowns remain targeted, which temper demand growth but don’t lead to sharp shocks… and the persistence of stimulus plans in the US in particular which are likely to support consumption growth. “Build Back Better” has many incentives to reduce the carbon intensity of growth and temper emissions, but they are likely to increase rather than decrease fossil fuel demand in the near-term.

With limited growth outside of OPEC+ as producers look to increase cashflow, the net result has been an increased reliance on OPEC and their counterparts in OPEC+ to meet this increased demand as production in the americas and Europe has been slow to pick up. This reflects new regulations in the US, a desire to grow cash etc. Current oil prices and slow actions by OPEC+ will prompt more production growth in market-driven markets, despite new net zero pledges. Rig counts are starting to rise in the US and Canada and we will likely see small increases. 

Iran remains a major wildcard with no agreement until the fall at the earliest. Ultimately they are likely to come to a deal given the pain of the sanctions, the pressure on the exchange rate which is adding to local inflation and drought. Moreover they don’t want to lose market share to neighbors or price takers. This could drag on for several months, with other countries taking market share. There do not seem to be any progress/plan B on Venezuela sanctions. Moreover, unlikely Iran, Venezuelan energy infrastructure has atrophied and its higher carbon potential new production means its both costly financially and in carbon budget. The lack of political plan B, the debt overhangs suggest oil production will continue to fall. 

Current oil prices are drag on global growth, especially as they are accompanied by other inflationary pressures. While DM central banks are likely to look past inflationary pressures, as credit and wages are manageable, EM countries don’t have that luxury. Large EM like Russia, Brazil, Mexico will hike further defensively, while fiscal policy is also more restrained even as Covid waves are more painful. And even countries with high real rates like Turkey will have little room to cut rates. Weaker currencies increase the cost of fuel locally reinforcing the impact of food price increases. This will be a drag on growth, hit rates and to a lesser extent equity markets and limit the shift into higher yield markets until 2022. 

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