OPEC keeps policy unchanged in a tightening market

OPEC+ agreed at its latest meeting to increase production in June by another 432k b/d, rolling over the targets that it has had in place since August of last year. In the brief statement that followed the meeting, OPEC+ “noted the continuing effects of geopolitical factors and issues related to the ongoing pandemic” but didn’t outlay any specific response to the sharp drop in oil demand in China caused by that country’s stringent Covid-19 restrictions or to a pending fall in oil supply from Russia as sanctions squeeze the country’s ability to export crude oil and products.

The roll-over of the production increase was highly anticipated by the market and price response has been fairly negligible. Brent futures popped higher briefly to around USD 114/b before fading the gains as financial markets generally were caught up in a broad sell off on May 5th. In the short-term, OPEC+ looks to be riding on the current waves of oil prices, rather than directly contributing to them. Markets look much more anxious about whether the EU will be able to agree on an embargo of Russian oil and product imports. The embargo would require unanimous assent from EU members though some that are highly reliant on Russian oil may receive carve-outs or a longer adjustment period than the six month’s the EU is targeting to wean itself off crude oil imports. Should the embargo get agreed that would hasten a decline in Russian oil production that is already in place and the impact would extend globally. The EU proposals would also prohibit EU firms from transporting or providing insurance for Russian cargoes, even if delivery is not intended for an EU-member nation.

The OPEC+ targeted increases also appear increasingly notional rather than actually impacting changes in physical oil supply. In April, production from the OPEC members of the producers’ alliance increased by just 10k b/d as higher output from Iraq, Saudi Arabia and the UAE was offset by declines elsewhere, notably Nigeria and Kuwait among producers that are part of the OPEC+ targets. Disruptions to supply in Libya also contributed to lower aggregate OPEC production last month.

While the risks to demand are salient in the near-term—China’s restrictive Covid-19 rules show no apparent sign of easing—there is a clearer off-ramp to address them via policies that accept “living with the virus” or the introduction of effective long-term vaccines. There is far less visibility on what kind of oil supply situation the global economy will be in six to 12-months down the road. Production from the US is increasing to be sure but at a slow pace: the most recent production estimates for the end of April have total output at 11.9m b/d, up just 100k b/d since the start of the year and down 1.2m b/d from a pre-pandemic peak of 13.1m b/d. Furthermore, a portion of US oil production may be earmarked to replenish the strategic petroleum reserve over the next several years following a release announced earlier this year of 180m bbl.

Our expectation following Russia’s invasion of Ukraine was that oil prices would hit elevated levels in Q2-Q3 this year as the full impact of sanctions on the country and a slow response from other producers contributed to a tight market. For now we maintain our target of an average of USD 120/b in Brent for Q2-Q3 and USD 115/b for WTI over the same period.