OPEC and partners short of a deal so far

OPEC+ has extended their ministerial meeting until July 5th after the producers’ bloc failed to reach an agreement on production levels for August 2021 onward. A proposal to increase output by 400k b/d each month until the end of the year and to extend the end-date of the OPEC+ cuts from April 2022 until the end of the year failed to win approval from the UAE. The uncertainty of whether a deal will be reached will add considerable near-term volatility to oil prices with both upside and downside potential.

The UAE favours an increase in the baseline level used for its production quota to better reflect its increased production capacity since the agreement took form in Q2 2020. The implications are that the UAE is proportionately cutting more relative to its production capacity and that a higher baseline level would allow it to actually increase output while still notionally contributing to aggregate production cuts. A unilateral increase in production is unlikely to win support from other major OPEC+ members, Russia and Saudi Arabia in particular who have been the architects of the production cut agreements for the past year and a half.

Two-way risks for oil

If the UAE maintains its position in favour of a higher baseline level, with or without other members claiming the same, and pushes forward with increasing production then the risk of a price war similar to what the market endured in March-April 2020 is high. In that scenario, we would expect substantial downside risks to spot oil prices, an erosion of the steep backwardation in the structure of futures markets but a considerable improvement for refining margins given that demand in key markets—the US and China in particular—is recovering well.

If OPEC+ rolls over their existing cuts at the outcome of July 5th then the probability for oil prices to remain elevated is higher. The oil market is already expecting considerable tightness and a rollover of end of July production levels would provide the market with less oil in H2 than the market had been expecting as an outcome of the July 1st meeting. However, a rollover agreement doesn’t address the UAE’s concerns about production baseline levels or the fact that many OPEC+ producers will be left unsatisfied with the inability to take full advantage of high oil prices. So while the risk of a disorderly end to the OPEC+ agreements could get pushed back from this meeting, it has not been completely eliminated.

When the outcome of Monday’s meeting becomes clearer we will make any necessary adjustment to our oil market balances and price assumptions. Our current expectation is for Brent futures to record an average of USD 70/b in Q3-Q4 2020.