Oil prices face a slippery road ahead
Potential price war, Covid Delta variant to weigh on market amid growing demand amidst global economic recovery
The threat of an Opec+ price war, the global spread of the Delta coronavirus variant and worries it could stall a worldwide economic recovery continue to weigh on the oil market in the short term, experts and analysts say.
Ratings agencies and industry insiders said the sector is likely to remain under pressure due to an impasse between major producers and if there is no immediate deal on production and supply quotas then more oil will be supplied to the market, which will hit prices.
“Opec+ has delayed its decision on the extent of crude oil production increases, raising questions about the alliance’s capacity to coordinate production and highlighting disagreements about supply policies,” Fitch Ratings says.
Benchmark US crude oil for August delivery ended up $1.62 at $74.56 a barrel on Friday while Brent for September delivery rose $1.43 to $75.55.
Prices have risen to their highest levels in three years due to a widening oil deficit, which is currently assessed at slightly more than one million bpd. Oil supply is constrained by the previous alliance output decision, while crude oil demand is growing as the global economy recovers from pandemic-related shocks. Earlier this week, Opec+ postponed for a third time its meeting to finalise the decision on the next phase of production increases and each country’s quota.
Saudi Arabia, Russia and the UAE are reportedly struggling to reach a compromise.
While those three nations have offered to increase the alliance’s production by 400,000 bpd each month from August to December, the UAE also wants to increase its baseline production — a starting point from which its cuts and increases are calculated, from April 2022 to account for its larger production capacity following investment. The country has capacity of about four mbpd and this may increase to five mbpd by 2030, based on its investment plans. However, the country has an Opec+ production quota of just over 2.7 million bpd in July.
“The gridlock tests the alliance’s ability and effectiveness to coordinate output decisions. In addition to the UAE, some other countries in the alliance, such as Iraq, Kuwait and Russia, are considering investments to increase production capacity. Allowing one country to raise its baseline capacity may spur similar demands from other members and jeopardise efforts to control crude supply, according to Fitch Ratings.
Although the price increases benefit crude oil producers, they are not driven by a structural deficit as about six million bpd of production capacity has been removed from the market by Opec+ and could easily be returned.
“Price wars are almost always quite short-lived — no one wins in the long term,” consultancy Rystad Energy said in a note.
“It is in the interest of the [Opec+] group to provide some leniency to the UAE and other supply hawks to produce a bit more within the framework of the deal.”
US crude stocks fall
US crude and gasoline stocks fell and gasoline demand reached its highest since 2019, the US Energy Information Administration said on Thursday, signalling increasing strength in the economy.
“A bullish EIA stock report helped the oil market rebound into the black. Clearly, US oil markets are tight. However... the only way to prevent further losses is for the threat of an Opec+ price war to be contained,” said Stephen Brennock of oil broker PVM.
Opec+ output policies have been the main driving force behind the oil price recovery in 2020-21, after a sharp decline in demand in March 2020 and a short period of unilateral decisions on production volumes taken by key alliance members. Although oil demand has been recovering, emerging coronavirus variants are a risk to this recovery, making swift output decisions key to preventing sudden price drops.
“We ultimately expect Opec+ to agree on production increases. In addition, Iran could add about 1.5 million bpd of supplies if US sanctions are lifted. Given the recovery of the global economy and mobility, the increased supply should mostly be absorbed by higher demand leading to a continued rundown in inventories this year,” according to Fitch Ratings analyst.
The improved pricing environment strengthened the liquidity positions of oil and gas producers, particularly for sub-investment-grade issuers. This helped to stabilise the rating outlooks of many sector issuers, particularly in the US.
“We rate through the cycle and assume the Brent price will moderate, settling at $53 per barrel in the medium to long term, after the market has rebalanced,” the rating agency said.
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