Over several days of negotiations beginning on July 1, OPEC+ met to discuss the possibility of returning some oil to the market, a routine step that would continue the process of unwinding the pandemic-induced production cuts agreed to in 2020.
Analysts had expected the proceedings to be mostly smooth, with additional supplies slated to return beginning in August, which would offset some of the rebounding demand. But the talks hit unexpected turbulence, with the United Arab Emirates playing the role of spoiler. For now, there is no agreement, an outcome that injects enormous uncertainty into the oil market.
Is a no-deal outcome bullish or bearish?
The UAE balked at signing onto an agreement that would increase OPEC+ production by an additional 400,000 barrels per day.
The UAE balked at signing onto an agreement that would increase OPEC+ production by an additional 400,000 barrels per day (b/d) beginning in August and also extend the entire arrangement until the end of 2022. Abu Dhabi wanted a higher baseline of production to work with, allowing it to ramp up production, which would dovetail with plans for a massive capacity expansion over the coming years.
The rest of OPEC+, especially Saudi Arabia, resisted agreeing to special treatment, and held the line. The deadlock resulted in no agreement. Initially, oil prices shot up on the news, with traders calculating that OPEC+ would no longer add the 400,000 b/d in August. After all, with no change to the agreement, the existing cuts remain. The result would be, markets seemed to assume, a dramatic tightening of the market in coming months with demand significantly outstripping supply.
“There is no decision about August and discussions still continue. The market needs that oil,” one OPEC+ source familiar with the talks told Reuters.
On Tuesday, July 6, oil prices suffered a mini-crash. Market attention shifted to an alternative outcome from a no-deal result.
“The cause of the sudden price dip could either be the market reaching a profit taking threshold, the increasing US and Russian pressure for an OPEC+ deal that will bring some market stability, but also the realization that there is a possibility of an OPEC+ rebellion that could bring unregulated output back to the market,” Louise Dickson, oil market analyst at Rystad Energy, said in a statement. “There is capacity to produce more oil, much more in fact, and the market expects that logic will soon prevail.”
A collapse of the agreement and a return to a free-for-all production regime “would be an extremely bearish development for a market that got used to rules and supply quota, in a world still affected by Covid-19,” Dickson said.
A flurry of other interpretations voiced similar conclusions. “The initial market reaction has been to push prices higher, based on the loss of the planned 0.4 million barrels per day (mb/d) increment to August loading programmes,” Standard Chartered wrote in a note to clients. “We think the turn of events is bearish; in our view anything that threatens the effectiveness of the OPEC+ framework opens up the downside for oil prices.”
The impact could in theory cut in two extreme directions: Maintaining existing cuts could overtighten the market and send oil prices skyward; or alternatively, a breakdown in the entire arrangement could return OPEC+ to a free-for-all that crashes the market all over again. The talks have been called off for now, so there is no consensus on what exactly that means for the group’s production going forward.
But most oil market analysts still see a third outcome as the most likely – despite the rocky negotiations, OPEC+ reaches an agreement in the coming days or weeks.
“The current impasse is not sustainable.”
“The current impasse is not sustainable, and we expect the eventual resolution to add to overall supply; either the UAE will stay inside the tent with a higher baseline, or it will choose (like Venezuela, Libya and Iran) to opt out of targets, causing further turbulence,” Standard Chartered added.
Goldman Sachs published a note with a similar conclusion about a deal as a likely scenario, although the investment bank hewed a bit more on the bullish side. Goldman’s “base-case remains for a gradual increase in [OPEC+] production through 1Q22,” while sticking with an $80-per-barrel Brent target for this summer.
“While the threat of a new OPEC+ price war is no longer negligible, its negative price impact would be dampened by a global market starting in a 2.5 mb/d deficit and in need of an extra 5 mb/d in production by year-end to avoid critically low inventories,” Goldman analysts wrote in a note.
Even in a “price war” scenario in which OPEC+ returns to a free-for-all, Goldman predicted that it would take two months before OPEC+ members return to the table for an agreement. The bank said such an outcome represents a $6-$9-per-barrel downside risk to their forecast.
Deal still likely, trouble ahead
The White House has inserted itself into the impasse.
The White House has inserted itself into the impasse, holding talks with Saudi officials behind the scenes. Saudi Arabia’s deputy defense minister Prince Khalid bin Salman is visiting Washington DC this week, and is scheduled to meet with national security adviser Jake Sullivan.
Consumer countries are growing nervous about prices rising too high. At the same time, with oil prices sitting close to multi-year highs, a free-for-all would squander the best pricing environment producer countries have had in a long time. All parties involved have too many reasons to abandon market management.
Put another way, the differences between the positions of the UAE and Saudi Arabia are minimal compared to the two extreme outcomes of no additional production going forward or a return to a free-for-all.
The turmoil at the OPEC+ meeting is not a trivial development.
Nevertheless, the turmoil at the OPEC+ meeting is not a trivial development. In fact, it may presage the challenges ahead. With demand rebounding, individual countries want to be able to increase production. “The pandemic held them together and now the post pandemic is breaking them apart. The UAE is sticking to their guns on wanting their baseline raised. They want to be able to produce more,” John Kilduff, a founding partner at Again Capital, told CNBC.
More significantly, the medium- and long-term is rife with uncertainty. As the energy transition holds, the incentives could push major Middle East producers to seek to monetize their reserves while they still have time. Under the OPEC+ arrangement, the UAE is limited to 3.2 Mb/d. But the Abu Dhabi National Oil Company (ADNOC) is aiming to ramp up its production capacity from 4.2 million barrels per day (Mb/d) today to 5 Mb/d by 2030.
The inability for OPEC+ to reach an agreement, even if only temporarily, raises red flags for the durability of the multi-year effort to manage the market in a cohesive manner.
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