The Fuse

Oil Prices Rise, OPEC+ Faces Decision

by Nick Cunningham | February 23, 2021

Oil prices have jumped to 13-month highs, with WTI rising above $61 per barrel and Brent solidly in the mid-$60s. Rising demand and progress on global vaccination efforts continue to bolster optimism, while supply growth remains subdued.

The tightening market provides OPEC+ with an opportunity to unwind the extraordinary production cuts put in place last year, and a wounded U.S. shale industry means there is less of a risk of a supply-induced downturn going forward.

Oil market tightens, analysts hike price forecasts

Brent hit $65 per barrel on February 23, a price last reached in early 2020. The rally comes as several investment banks issued bullish forecasts for crude over the coming months.

The rise in prices over the past two months is the result of “better than expected demand and still depressed supply once again creating a larger deficit than even we expected in January and February, with timespreads strengthening,” Goldman Sachs wrote in a note to clients on February 21. The bank’s analysts added that the deficit will continue to widen into the spring due to lag in production increases from OPEC+ at a time when demand ratchets higher.

Putting it all together, oil prices “will rally sooner and higher,” the investment bank said.

The market deficit puts OECD inventories, which ballooned last year to historic heights, on track for normalization by summer, Goldman said. Putting it all together, oil prices “will rally sooner and higher,” the investment bank said. Goldman forecasts Brent averaging $70 per barrel in the second quarter and $75 per barrel in the third, both $10 higher than a previous forecast. Oil traders with Socar Trading SA said that oil could hit $80 by the summer.

Morgan Stanley raised its pricing forecast for Brent to $70 for the third quarter. “New COVID-19 cases are falling fast globally, mobility statistics are bottoming out and are starting to improve, and in non-OECD countries, refineries are already running as hard as before COVID-19,” Morgan Stanley said in a note.

Meanwhile, the Texas energy crisis may sideline 2 to 4 million barrels per day (Mb/d) for a few weeks, taking a chunk out of global supply, at least temporarily. The impact was offset by outages at several major Texas refineries.

The flurry of bullish price forecasts may itself have played a part in juicing prices. Oil surged on February 22 after major investments banks issued their reports.

Bank of America Merrill Lynch largely agreed with the optimistic outlook for prices, and the bank hiked its forecast as well. However, it noted that there are some downside risks, including the potential return of some 2 Mb/d. Meanwhile, the OPEC+ cuts of 9.7 Mb/d (less than that currently) helped tighten the market and drain inventories, but the coordinated cuts also simply shifted that production into spare capacity. While not actively producing, that capacity will need to come back online.

Should OPEC+ increase production?

Indeed, the tightening of the oil market gives OPEC+ a lot of runway to unwind the cuts. The group is expected to make a highly-anticipated decision in early March on what to do next. The tentative plan is to add another 0.5-Mb/d increment of supply back on to the market, but the recent price gains could spark a more significant change in policy.

The tightening of the oil market gives OPEC+ a lot of runway to unwind the cuts.

However, Saudi Arabia and Russia, the coalition’s most powerful producers and de facto decisionmakers, are not necessarily on the same page. Saudi Arabia has suggested that it would unwind its voluntary 1 Mb/d of additional cuts announced earlier this year, but Riyadh is otherwise in favor of not adding too much supply back onto the market over fears of sending oil prices back down. Russia, on the other hand, is much more eager to increase production.

While Russian energy minister said in mid-February that the “market is balanced,” his Saudi counterpart warned against declaring victory “too early.” Russia’s view is to use the market tightness to add supply and regain market share; Riyadh would seemingly prefer to stay the course and let prices rise.

OPEC+ faces some risks either way regardless of what it decides, but the lack of expected growth from U.S. shale grants OPEC+ a degree of flexibility. OPEC lowered its forecast for U.S. shale recently, estimating the sector declines by 140,000 barrels per day in 2021. Indeed, a long line of shale executives told investors and analysts on fourth quarter earnings calls that they would not return to aggressive drilling, even with higher oil prices. Having burned too much cash and too many bridges, there is a ton of pressure on shale E&Ps from investors to show restraint after a decade-long debt-fueled drilling boom.

Nevertheless, because of the enormous spare capacity sitting on the sidelines, OPEC+ will need to maintain market management “beyond April 2022,” according to Bank of America, the month at which the deal is scheduled to phase out. “[G]lobal mobility remains constrained, inventories are still high, and OPEC+ sits on nearly 10mn b/d of spare capacity,” Bank of America said on Tuesday. “These headwinds will not disappear overnight.”