OPEC+ has been withholding 2.2 million barrels of oil supply daily for well over a year now—and it might have to start thinking about these cuts as a long-term policy. The market just keeps refusing to respond to them as OPEC+ wants.
The idea of the production cuts was the same as the idea of all OPEC cuts before them: curb supply, let demand take care of any perceived or real surplus, watch prices go up, and then release the withheld supply.
It has always worked before. It should have worked again. But it didn’t.
It isn’t working this time because of two things: algorithmic trading and unrealistic expectations about Chinese demand growth. The latter factor determined an overwhelmingly bearish sentiment among oil traders, and the former amplified it out of any reasonable proportions. Some analysts are warning that oil is underpriced and the market is in for a correction, but they are lonely voices in a sea of demand pessimism.
It is in this context that OPEC+ delayed its latest meeting that was due to take place—virtually—on Sunday but will instead take place next Friday. The reason given for the delay was a scheduling conflict, but the group may want to use the extra time to think where it is going over a longer term than a month from now. Because there are precious few factors working for OPEC+ and its goal for higher oil prices.
One of these factors is the fundamentals situation in oil. Demand for oil keeps surprising to the positive while non-OPEC supply growth—except in Guyana—is not really living up to the hype, with growth in the U.S. shale patch set to slow down, despite Trump’s presidency. Yet no one trading oil seems to care much about fundamentals because they are watching China and its oil demand fluctuations.
The other factor that could potentially aid OPEC+ in its efforts to make oil more expensive is geopolitics. A Trump presidency will probably mean tighter sanctions on Iran, and that would, in turn, mean fewer Iranian barrels reaching international buyers, which would additionally crimp supply, potentially boosting prices. Interestingly, traders are still ignoring this even as analysts step up the warnings.
“We think that oil prices are about $5 per barrel undervalued relative to the fair value based on the level of inventories,” Goldman Sachs’ co-head of global commodities Dan Struyven told Reuters recently. Echoing the sentiment, Morgan Stanley’s Martijn Rats suggested in comments to the publication that the whole oil surplus “story” is not yet a fact—and may never become a fact because producers tend to respond to the risk of a surplus by curbing production.
Still, prices remain depressed, and whenever they do inch up, they do so modestly in response to a production outage or an escalation in the Middle East or Ukraine—and these jumps never last. There’s always some news report about Chinese demand or the latest from the International Energy Agency that quickly puts an end to the climb.
This means that OPEC+ may need to get used to the thought of more permanent supply limits. Instead of talking about policy revisions every month, it might want to make the period between these revisions longer, as it did at the start of the latest round of cuts. Instead of giving the market any hint of a suggestion it might start bringing back barrels, however unrealistic such a move may be, OPEC+ might want to eliminate this additional source of bearish sentiment.
There have been several oil price dips so far this year purely on trader expectations that OPEC+ would start unwinding the cuts only because it had said it would do so if the price was right—with most missing the conditional part of that sentence. What most are also missing is the fact that the International Energy Agency keeps getting demand and supply forecasts wrong and keep using these forecasts as basis for business decisions.
“I think that there’s no room for them to increase and the market will remind them of that when necessary,” Gunvor’s chief executive Torbjörn Törnqvist said as quoted by Bloomberg recently. He is right, of course—not because there is a huge oversupply because there isn’t—but because there is the perception of oversupply and that perception is dictating prices. It will take quite a while to change this perception. Or may not.
The oil market is “trying to price in a future supply glut that has yet to arrive,” Jeff Currie, energy strategist for Carlyle Group, formerly with Goldman, told Bloomberg, adding that the very anticipation of such a glut would motivate producer behavior aimed at avoiding it. Chances are, however, that most won’t pay attention to this warning—and that’s good news for OPEC+ further down the road when the supply shock does what shocks do—surprise everyone and send prices soaring because the IEA was wrong yet again. Until then, however, OPEC+ might consider treating the production cuts as permanent.
By Irina Slav for Oilprice.com
