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Commodities Corner: To pause or not to pause oil output increases is the question OPEC+ faces as it meets Wednesday

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A lot has changed since the Organization of the Petroleum Exporting Countries and their allies decided last month to start raising oil output, in a move to unwind the production curbs they put in place last year.

Some analysts say, however, that the best option the producer group, known as OPEC+, could take at Wednesday’s meeting may be to leave the current agreement in place.

Among the biggest concerns for OPEC+ is the coronavirus delta variant and its impact on developed and emerging economies, said Rohan Reddy, analyst at Global X, a provider of global exchange-traded funds.

Progress is being made on the vaccination front, and the “delta variant is likely to be eventually contained, which would lead to higher energy demand,” he said.

The market is also looking to a likely rise in oil output from other nations next year, including the U.S., as well as to actions by the U.S. Federal Reserve, which may be considering tapering its bond purchases as soon as this year in a move that could strengthen the U.S. dollar, putting pressure on dollar-denominated oil prices, said Reddy.

Still, “even with some of these concerns, OPEC+ is very pragmatic in its policies, so these concerns have all been weighed over the course of 2021,” he told MarketWatch. With the group scheduled to meet on Sept. 1 to review its production policy, OPEC+ will “likely take all developments into account…before making its decision.”

Oil prices traded a bit higher from their settlement on July 19, the first full trading day after OPEC+ announced a decision to increase oil production by 400,000 barrels a day each month from August, to eventually undo all of the output curbs put in place last year in response to the collapse in energy demand wrought by the COVID-19 pandemic.

On the New York Mercantile Exchange, October West Texas Intermediate crude
CLV21,
+1.91%

CL.1,
+1.91%
,
the U.S. crude benchmark, settled at $68.74 a barrel Friday. Front-month prices had settled at $66.42 on July 19. Global benchmark October Brent crude
BRNV21,
-0.11%

ended at $72.70 Thursday, up from $68.62 following OPEC+’s July decision.

A standoff between Saudi Arabia and the United Arab Emirates over baseline production levels delayed July’s OPEC+ decision on output. OPEC+ agreed in April last year to cut overall crude-oil production by 10 million barrels per day from May 1 through June 30 of 2020, followed by a gradual easing of those cuts.

Supply and demand signals

“OPEC+ is likely being extremely vigilant about high-frequency demand signals at the moment,” said Matt Smith, director of commodity research at ClipperData.

“Parts of Asia are already waving a red flag in terms of demand and have been for a while,” he said. Still, reports Monday this week that China had zero new COVID-19 cases for the first time since July helped ease some worries about oil demand.

“If the group sees ongoing weaker demand for their crude, they will likely hit the pause button on production increases,” said Smith.

So far, however, OPEC+ has taken a “diligent approach over the course of the pandemic,” said Reddy.

He believes OPEC+ will “still gradually unwind its oil output cuts placed last year, when the demand was hit by the pandemic.”


OPEC+ will “still gradually unwind its oil output cuts placed last year, when the demand was hit by the pandemic.”


— Rohan Reddy, Global X

Market share

Meanwhile, loss of market share to U.S. shale oil producers probably isn’t a key concern for OPEC this time around.

In the past, U.S. shale oil producers served as a swing supplier in the oil market, but that’s probably “not the case right now,” Dallas Fed President Rob Kaplan told MarketWatch Senior Reporter Greg Robb, in an interview on Thursday. “It’s more likely to be OPEC.”

Read more on the interview: Fed’s Kaplan tells MarketWatch a gradual taper will give markets best chance to adjust

The producer group’s decision will “help dictate the price,” and depending on what those decisions are, there “may be periods where we’re vulnerable to supply shortages,” said Kaplan.

OPEC’s goal will likely be to “maximize cash flow and not let prices get so high that it creates incentives for [U.S.] shale to produce more,” Kaplan told Robb. OPEC may see U.S. shale producers as being “very slow to meaningfully increase production,” he said. He points out that companies have said they’re going to limit oil production and are reluctant to use cash flow to invest in new drilling and instead, are “more likely to return it to shareholders and dividend and share repurchase[s].”  

That gives OPEC “some latitude to maybe not increase production as much as they might,” Kaplan said, suggesting that there’s less concern that OPEC will lose market share to U.S. shale producers.

Surprise move?

OPEC+ could still surprise the market, particularly as there is some speculation that producers may consider a pause in the planned production increases.

However, it would likely take a “deterioration in the global economy or a major downswing in the COVID-19 recovery in major emerging markets like China, or major developed markets, like the U.S.,” for a pause to take place, said Reddy.

The U.S. government has pushed for more oil on the global markets. On Aug. 11, U.S. President Joe Biden said he “made clear to OPEC…that the production cuts made during the pandemic should be reversed as the global economy recovery, in order to lower prices for consumers.”

Separately, in a statement that day, U.S. National Security Adviser Jake Sullivan said the Biden administration was “engaging with relevant OPEC+ members on the importance of competitive markets in setting prices,” and referred to OPEC+’s July agreement to gradually boost output each month starting in August as “simply not enough.”

For now, with “clearer policies from OPEC+, the impact of the delta variant on oil prices is being supported from the supply side,” said Reddy.

“Global economies continue to recover from the pandemic and are seeing rising demand in global activity,” he said. “We believe, as this continues, it will lead to higher energy demand…especially going into 2022.”

Reddy said Global X expects to see a trading rage of $65 to $70 for WTI oil and $75 for Brent for the rest of this year.

Greg Robb, a senior reporter in Washington, contributed to this report.

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