OPEC+ may face long-term production cuts

OPEC+ has been withholding 2.2 million barrels of oil per day for well over a year – and may need to start thinking about these cuts as a long-term policy. The market simply continues to refuse to respond the way OPEC+ wants.

The idea of ​​the production cuts was the same as the idea of ​​all OPEC cuts before them: curb supply, let demand provide any perceived or actual surplus, watch prices rise, and then release the withheld supply.

It has always worked so far. It should have worked again. But that wasn’t the case.

It’s not working this time for two reasons: algorithmic trading and unrealistic expectations of demand growth in China. The latter factor created a predominantly pessimistic mood among oil traders, and the former amplified it beyond measure. Some analysts are warning that oil prices are undervalued and the market is headed for a correction, but they are lone voices in a sea of ​​demand pessimism.

With this in mind, OPEC+ has postponed its final meeting, which was due to take place – virtually – on Sunday, but will instead take place next Friday. A scheduling conflict was cited as the reason for the delay, but the group may want to use the extra time to think about where to go in more time than a month. Because there are hardly any factors that speak in favor of OPEC+ and its goal of higher oil prices.

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One of these factors is the fundamental situation with oil. Oil demand continues to surprise on the upside, while non-OPEC supply growth – except in Guyana – doesn’t really live up to the hype as US shale growth looks set to slow despite Trump’s presidency. But no one who trades oil seems to care much about fundamentals because they keep an eye on China and the fluctuations in its oil demand.

The other factor that could potentially help OPEC+ in its efforts to make oil more expensive is geopolitics. A Trump presidency will likely mean tougher sanctions on Iran, and that would in turn mean fewer Iranian barrels reaching international buyers, further reducing supply and potentially driving up prices. Interestingly, traders are still ignoring this even as analysts are stepping up their warnings.

“We believe oil prices are undervalued by about $5 a barrel relative to fair value based on inventory levels,” Dan Struyven, co-head of global commodities at Goldman Sachs, recently told Reuters. Morgan Stanley’s Martijn Rats echoed this sentiment, suggesting in his comments to the release that the whole oil surplus “story” is not yet a fact – and may never become a fact because producers tend to to respond to the risk of a surplus by cutting back on production.

Still, prices remain low, and whenever they rise marginally, they do so in response to a production shortfall or escalation in the Middle East or Ukraine – and these jumps never last. There is always news about Chinese demand or news from the International Energy Agency that quickly puts an end to the surge.

This means OPEC+ may have to get used to the idea of ​​more permanent production limits. Instead of talking about policy revisions every month, one might want to extend the period between those revisions, as was the case at the start of the last round of cuts. Rather than giving the market an indication that it might begin pumping back barrels, unrealistic as such a move may be, OPEC+ may want to remove this additional source of bearish sentiment.

So far this year there have been several drops in oil prices driven solely by traders’ expectations that OPEC+ would only begin unwinding cuts because it had said it would do so if the price was right – with most being conditional Part of this sentence was missing. What also escapes most people is the fact that the International Energy Agency consistently gives incorrect demand and supply forecasts and continues to use these forecasts as the basis for business decisions.

“I think there is no room for an increase, and the market will remind you of that if necessary,” Gunvor CEO Torbjörn Törnqvist said, recently quoted by Bloomberg. He’s right, of course – not because there is a huge oversupply, because there isn’t – but because there is a perception of oversupply and that perception dictates prices. It will take quite a while to change this perception. Or maybe not.

The oil market is “trying to price in a future supply glut that hasn’t happened yet,” Jeff Currie, energy strategist at Carlyle Group, formerly of Goldman, told Bloomberg, adding that the mere anticipation of such a glut would motivate producers’ targeted behavior to avoid it. However, there’s a chance that most won’t heed this warning – and that’s good news for OPEC+ down the road if the supply shock does what shocks do: surprise everyone and send prices soaring because the IEA was wrong once again. Until then, however, OPEC+ may consider making the production cuts permanent.

By Irina Slav for Oilprice.com

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