OPEC and allies to focus on demand risks

OPEC+ holds its next ministerial meeting on April 28th and we expect their focus will be on near-term demand risks related to an uptick in Covid-19 cases globally. While Covid-19 vaccines have been deployed globally, their uptake as a share of populations is widely dispersed and global daily case levels are now rising at their largest amounts since the pandemic began.

At their last meeting only at the start of April, OPEC+ agreed to increase production levels by 2m b/d between May and July, including Saudi Arabia unwinding its voluntary cuts of 1m b/d. Whether or not the market will be able to sustain that level of increase depends on how badly demand is being affected by the current rise in the number of Covid-19 cases in India and resultant lockdowns in key centres of the economy. Oil refineries in India have already lowered processing rates thanks to demand dropping off as economically significant states enter lockdown. As the daily number of new cases has yet to hit a plateau the near-term economic hit is likely to be sharp and may feed into the summer months.

India is by no means alone in struggling with a new uptick in cases. Many emerging markets haven’t had the same access to vaccines as developed economies and parts of South America and South-east Asia have needed to reimpose lockdowns or other restrictions. The risk of a broader drop in oil consumption across normally fast-growing emerging economies is high and like in 2020 could come about suddenly.

Market reaction has been contained so far

So far market reaction to the risk of a drop-off in India’s demand has been limited. Brent futures have oscillated between around USD 65-68/b in the last few weeks with WTI exhibiting a similar pattern, albeit at a slightly lower band of around USD 61-64/b. Time spreads have actually shown an improving trend lately with 1-12 month spreads in Brent at more than USD 4/b compared with less than USD 3/b earlier in the month. Options markets are also not highlighting substantial immediate downside risks to oil with the bearish skews for front-month Brent and WTI options considerably lower than they were a month ago.

With market structures and prices showing little response to a potential sharp drop in oil demand, OPEC+ may choose to carry on adding volumes as planned earlier in April in the hope that strong vaccination rollouts in some economies—the US, UK and now parts of the EU—will help to pick up the slack of a drop in emerging market oil demand. However, OPEC+ has shown itself prone to surprise action at its meetings so far this year so we won’t rule out the potential that they curb some of the 2m b/d in supply additions to help firm up prices at around current levels.

Iran-US talks present another downside risk

Parallel to the OPEC+ meeting are the ongoing negotiations between parties to the JCPOA, the Iran nuclear deal. Talks have been held in Vienna and have up to now been reported as “constructive” with the potential for the lifting of some US sanctions on Iran. However, there has been a hardening of positions in recent days with the US seemingly willing to support lifting nuclear related sanctions while keeping some of the others that were introduced during the Trump administration in place. Iranian negotiators seemingly want to have all sanctions—whether related to the nuclear issue or not—lifted before they commit to returning to the terms of the nuclear deal.

We had not counted on Iran returning in a meaningful way to oil markets this year and as such don’t anticipate an increase in production in our assessment of oil market balances. The country is producing roughly 1.5m b/d below Q2 2018 levels, when the Trump administration withdrew from the JCPOA. Were there to be a diplomatic breakthrough the potential for Iranian oil to rush back into markets, likely at a discount to attract buyers, would add a substantial downside risk to oil prices. We would expect OPEC+ to closely track the diplomatic negotiations between Iran and the US and seek to reintegrate Iran into a production target system quickly if it were able to export crude freely.