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OPEC faces ‘worst of both worlds’ with oil prices in limbo ahead of committee meeting

Saudi Arabia’s Minister of Energy Prince Abdulaziz bin Salman Al-Saud speaks via video link during a virtual emergency meeting of OPEC and non-OPEC countries, following the outbreak of the coronavirus disease (COVID-19), in Riyadh, Saudi Arabia April 9, 2020.

Saudi Press Agency | Reuters

OPEC is facing “the worst of both worlds” with the current oil market demand outlook, S&P Global Platts’ head of EMEA news said Wednesday ahead of the group’s Joint Ministerial Monitoring Committee (JMMC), where it will announce recommendations for production policy along with its non-OPEC allies. 

“This demand issue is really key here,” Andy Critchlow, a long time oil market veteran, told CNBC’s “Squawk Box Europe,” pointing to the 13-member organization’s outlook for global oil demand next year at 97.7 million barrels per day. 

“That’s a car crash. Let’s face it… this is not a great look for the outlook for oil.”

While the figure is expected to mark the largest one-year jump ever recorded, it’s significantly below the already lukewarm demand figure of 99.8 million bpd recorded at the end of 2019, pre-coronavirus. And it’s a dire forecast for producers who have invested billions of dollars in boosting production capacity. For OPEC, that’s significant spare capacity that will be left untapped. 

International benchmark Brent crude has hovered in the $ 40-$ 45 per barrel range for the last five weeks, signalling a substantial recovery from its multi-decade trough of around $ 19 per barrel in March brought on by global coronavirus lockdowns and a Saudi-Russia oil price war. But the commodity still remains in correction territory, down more than 30% year-to-date and at a level Critchlow says paints a “bleak picture” for the alliance. 

Not only that — it’s also just enough for some U.S. shale operations to survive, he said, providing some oxygen to OPEC’s American competitors. The higher the prices, the greater relief for shale. 

“Brent hovering around, you know, $ 40, $ 45 a barrel at the moment, that’s not good for OPEC,” he said. “That doesn’t get them there economically. And even worse, around $ 45 a barrel, that’s enough to kind of keep the U.S. oil industry, the shale revolution on its legs. So you’ve kind of got the worst of both worlds for OPEC.”

On the other hand, extending the historic production cuts of 9.7 million bpd that the OPEC and non-OPEC alliance began in May could be seen as self-defeating, pushing prices too high and derailing the fragile demand recovery of the past several weeks.

The longer OPEC+ keeps its unprecedented barrels off the table, the more it incentivizes higher cost U.S. shale producers.” 

Ehsam Khoman

Head of MENA Research, MUFG

Wednesday’s JMMC meeting will deliberate how to proceed on the cuts, with markets largely expecting that the previously agreed plan to reduce cuts to 7.7 million bpd — adding roughly 2 million bpd of crude back onto the market — will be implemented from August 1.  

“They (OPEC) are in this horrible kind of grey area of, they can’t pump up prices enough to support their own economies,” Critchlow continued.  “They do need to bring more oil back on the market, they need the market to respond. And with these prices, it’s just not going to cut it. It’s a bleak picture.”

‘A real test’ for OPEC’s strategy

Ehsan Khoman, head of MENA research at Dubai-based MUFG, described a similar dilemma for the group. 

With oil prices shifting to what MUFG sees as cyclical tightening, “current spot prices are at levels that could prove self-defeating to the market rebalancing, which in conjunction with the large inventory overhang, creates a real test for OPEC’s current strategy,” Khoman told CNBC.

“Whilst large cuts are needed to normalize excess inventories, the longer OPEC+ keeps its unprecedented barrels off the table, the more it incentivizes higher cost U.S. shale producers.” 

That being said, current oil prices are still far from ideal for shale, which is being barraged with a wave of bankruptcies as firms go under and rigs get taken offline. For shale’s many highly indebted producers, $ 40 oil is not enough to manage those debts. 

It’s also important to remember that there is much more downside risk to OPEC’s 2021 demand forecast of 97.7 million bpd than upside. The projection is predicated on everything going right — the virus being contained, stimulus measures continuing, no disruptive trade wars.

Paola Rodriguez-Masiu, a senior oil markets analyst at Rystad, wrote Wednesday: “For now, we believe that the oil market is heading to the right direction, with oil prices registering moderate gains.”

But, she cautioned, “the price recovery is fragile and hinges not only upon avoiding a derailing of the demand recovery, but also OPEC+ adherence to quotas as they slowly ramp-up output in August.”

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