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Edward Bell - Senior Director, Market Economics
Published Date: 18 February 2021
As the next OPEC+ ministerial meeting at the start of March nears, oil markets appear to be in strong shape. Front month futures prices have gained more than 20% since the start of the year and forward structures have pushed into wide backwardations. Moreover, oil inventories are falling and demand indicators are pointing upward, albeit modestly. The choice for OPEC+ will be whether to add incremental volumes to the market in Q2—as per the terms of their production cut agreement—or continue to let the market run hot and risk a demand backlash and positive reaction from non-OPEC+ producers.
Source: Bloomberg, Emirates NBD Research
If OPEC+ were to increase production in Q2 in line with the bloc’s agreement, a little more than 2m b/d would be added on to markets with most of the additional volumes coming from OPEC itself. Saudi Arabia’s output alone would increase by around 1.5m b/d as it unwinds the voluntary additional cuts of 1m b/d that it enacted in February-March this year.
While a 2m b/d production increase would appear large in isolation, we estimate it would push oil market balances into a surplus of around 1.2m b/d. That would mark a sharp shift upward from our estimate of a Q1 deficit of around 200k b/d but does not represent a major upside risk to inventory levels in the context of the enormous build witnessed in 2020. The OPEC+ production agreement would restrict output for the rest of 2021 to the same level as Q2, helping to bring inventories down for the year as a whole.
The additional volumes in Q2 would certainly be welcome for OPEC+ economies. Brent futures in 2021 have so far recorded an average of around USD 57/b, higher than our Q1 target of USD 47.50/b, but still short of fiscal breakeven levels for GCC producers (see our latest view on GCC fiscal conditions). With vaccination rates improving in major economies and markets pricing in more activity ahead, there are few near term impediments to oil prices holding on to current levels even with additional barrels coming into the market.
By contrast, were OPEC+ to maintain their restrained Q1 levels for Q2 we would expect to see more fuel thrown on to the fire and potentially push prices out of the USD 50-60/b range they have traded in for much of the year. OPEC+ members themselves may find sustained pricing above USD 60/b too attractive for oil diplomacy to hold, threatening the return of upwards of 8m b/d should a price war scenario emerge. That is not our central scenario for OPEC+ this year—the memories of the prices collapse in in March-April 2020 will be entrenched for some time—but it is nevertheless an outside risk to the market.
A far more salient threat though will be the response from producers outside of OPEC+. There are already signs of improvement in several producers with non-OPEC output expected to expand by 900k b/d in 2021, of which the majority will be provided by countries outside of OPEC+ entirely. The IEA expects Canada to add around 380k b/d to take output to almost 5.7m b/d on average this year while Brazil should add around 160k b/d and produce more than 3.2m b/d.
The major unknown is the outlook for the US. All major forecasting agencies—IEA, OPEC and EIA—expect to see output from the US holding to a narrow range around 11m b/d in terms of crude output. The near term outlook is for US production to fall back sharply as a result of freezing weather that is impacting fields across the central parts of the country, including key fields in Texas. However, as prices continue to climb higher the chances for a production recovery in the second half of 2021 grows stronger. A Dallas Fed survey of exploration and production companies revealed that 50% of firms had plans to increase capex in 2021, either slightly or significantly. But the survey was taken when WTI prices were around USD 13/b below where they are at the moment and the forward curve was only tentatively moving out of backwardation. WTI prices for the second half of 2021 are currently trading at an average of USD 57/b, more than USD 10/b higher than where the same firms surveyed by the Dallas Fed were using for their 2021 capex plans.
Source: Dallas Federal Reserve, Emirates NBD Research
Exploration and production firms in the US have been increasing their activity in the last months, adding rigs for the last 12 weeks in a row as of early February. While the total number of rigs is still a fraction of where activity began 2020, the improvement in spot prices and forward prices is clearly attracting more activity toward the sector.
Source: Bloomberg, Emirates NBD Research
The level of drilled but uncompleted wells (DUCs) in US shale basins began to slide from the middle of last year as the drilling rig count plummeted but nevertheless remains at a high level of nearly 5,000. An uptick in activity in H1 2021 could help to push the stock of DUCs higher, adding another reserve of potential output growth even if prices were to dip back from current levels.
Our baseline assumption is that OPEC+ will increase output from Q2 in line with the initial terms of the production cut agreement. However, as energy ministers from the bloc are now meeting on a monthly basis we would expect output levels to be calibrated to near-term conditions and hence adding 2m b/d in short order may spark a rapid market correction although we doubt it would push prices far below USD 50/b. An output increase in the order of 1m b/d for Q2 may help to take some of the excess vigour out of the markets but allow prices to consolidate in a USD 50-60/b range. Improving conditions later in the year should allow prices to record a more sustained gain even with additional barrels coming into the market.
OPEC and allies to decide on future