OPEC cooperation with partners likely to persist

OPEC+ meets this week (June 30 th) to assess oil market conditions and review their plans to increase production in July and August by 648k b/d, around 50% faster than the pace they had been targeting for monthly increases since July 2021. We noted earlier this month that the larger monthly increases may end up being notional given that many OPEC+ members are already struggling to hit their output targets thanks to running up against capacity constraints or, in the case of Russia, are inhibited by sanctions on trade in oil.

We would expect OPEC+ at a minimum to rubber stamp the output increases for the next two months but the critical issue becomes what happens after August. The current OPEC+ agreement—production adjustments in the parlance of the exporters’ bloc—is due to end in September this year as outlined at the meeting in July 2021. From that point on, OPEC+ members are free to adjust their output in line with their view of market conditions. However, given the commentary from OPEC+ ministers over the last several months, we would expect further cooperation to persist after September, even if a formal integration of core OPEC and OPEC+ countries is still viewed as unnecessary.

While the prospect of OPEC+ producing at full tilt post-September may be welcomed by a global economy reeling from currently high energy inflation, there is a major difference between what can be agreed and what can actually be achieved. Among the OPEC core, only Saudi Arabia and the UAE have meaningful spare capacity, estimated at around 2.7m b/d as of May this year according to the IEA. Nigeria and Libya have room notionally to increase but long-standing issues around maintenance in the former and persistent political unrest in the later keep their ability to respond to high oil prices minimal.

Limited room for error among OPEC members

Source: IEA, Emirates NBD Research

Worryingly for the energy inflation narrative, while spare capacity of roughly 3.3m b/d (if we add up all OPEC members that could increase output) may seem ample, it must be measured against demand conditions that are still being negatively affected by China’s restrictive Covid-19 policies. China’s oil demand is estimated to be down by more than 1m b/d y/y in Q2, according to the IEA and is on course to recover by 1.4m b/d by Q4 this year. That will claim a large amount of the spare capacity from OPEC members and leave oil markets with little room for error in the turnover of Q4 2022-Q1 2023.

In recent days there has been a flurry of diplomatic activity to restart talks on restoring the JCPOA, the Iran nuclear deal that the US abandoned in 2018. Talks had broken off earlier this year despite reportedly having been close to a deal several times. We aren’t sure that much has changed in the diplomatic postures of the US or Iran that would make a deal easier to achieve, even as additional volumes from Iran would likely be welcomed by oil markets. Moreover, a successful outcome of the visit of US President Joe Biden to Saudi Arabia, while not ostensibly about oil, may hinge on what place Iranian barrels occupy in oil markets in the months to come.

Oil prices have turned lower in June, falling from around USD 120/b at the start of the month, down to as low as USD 110/b last week as financial markets generally begin to price in more of a recession fear. But while spot prices have stumbled, time spreads are still pointing to a tight market. The spread between the 2nd and 3rd expiring contracts (to avoid the distortion of the near to expiry front month) has moved up to USD 3/b by the end of June, hardly signalling a market that is comfortable that a dip in demand will accommodate current supply restrictions.

Time spreads in oil ask...what recession?

Source: Bloomberg, Emirates NBD Research