Just a few days ago, the price of Brent crude oil was slightly above 80 USD per barrel on the stock exchange. In the context of inflation, this may not be low, but it is far from the peaks of the last two years, when it often cost 90 or even 100 dollars per barrel. Recently, investors have not been convinced about the strength of demand in the two main drivers of the global economy: the USA and China. At the same time, the OPEC+ cartel has been maintaining voluntary production cuts for a long time, leading to an artificial balancing of the market or even a slight deficit, which supports relatively high oil prices. However, it turns out that the OPEC+ decision regarding the future of the voluntary cuts agreement is not as important as geopolitics. It was the latest escalation of the situation in the Middle East that led to a significant rebound in oil prices. Will the OPEC+ decision further increase prices?
Tensions in the Middle East
In recent weeks, the situation between Israel and Hamas has not been on the front pages of newspapers. On the other hand, the helicopter crash with the Iranian president on board has once again focused journalists’ attention on this region. The death of the Iranian president and foreign minister led OPEC+ to postpone the ministerial-level meeting by one day to June 2nd. Additionally, this meeting will be held via video conference, rather than physically as previously planned. However, this is not the end of the increase in geopolitical tensions in the Middle East. Israel bombed a refugee camp in Rafah, which sparked international opposition to the continuation of military actions in the Gaza Strip. Furthermore, there were two attacks on tankers in the Red Sea by the Houthis from Yemen, which could once again disrupt the regularity of supplies of the world’s most important commodity. The combination of all these events led to oil rebounding by about 5% from last Friday’s lows and is on track for the largest weekly gain since the end of March.
OPEC+ Decision
The expanded OPEC+ cartel is reducing oil production by almost 6 million barrels per day! This is more than 5% of global oil supply. This figure includes exactly 3.66 million barrels per day of cuts related to the COVID-19 pandemic, which are to be maintained until the end of this year. Additionally, in November last year, most OPEC+ countries decided to join Saudi Arabia and Russia in voluntary cuts, reducing production by an additional 2.2 million barrels per day. Initially, the voluntary cut was to last until the end of March, but it was decided to extend it until mid-this year. Currently, it is expected that OPEC+ will decide to extend this cut, so the lack of such a decision could be a major disappointment for the oil market. Theoretically, the compliance of production cuts with imposed limits is also important. According to calculations by Bloomberg, Reuters, and other data-providing agencies, production among the participating countries is about 200,000 barrels per day higher than it should be. This is not a large number from the perspective of the entire oil market, but it is important when looking at how the global balance behaves. OECD stocks have remained essentially unchanged for many months, indicating that demand may indeed have some problems. Therefore, the best scenario for oil is not only to extend voluntary cuts until the end of this year but also to increase compliance with production limits or even attempt to catch up on cuts.
China is Slowing Down, Demand in the USA is Rebounding
China accounted for about half of the entire increase in oil demand last year. Indeed, the country recorded daily fuel demand of over 15 million barrels per day last year, which has now decreased by about 0.5-1.0 million barrels per day. Additionally, there is no visible increase in interest in building up reserves in China. Stocks at ports are low, although on the other hand, global stocks on the water have risen to levels significantly higher than the 5-year average, which may suggest a possible rebound in imports to China. Furthermore, there is not much talk about India, which is currently a growth market but still lags behind China in terms of nominal demand levels.
At the same time, demand in the USA is beginning to show signs of recovery. In the first part of the year, oil stocks rebounded, but at the same time, stocks of petroleum products decreased. Oil production in the USA remains high, around 13 million barrels per day, but the small number of drilling rigs and fracturing teams may suggest that production in the world’s largest economy will not increase as much as international energy agencies or OPEC expect. This could be a potential problem for Joe Biden, who is seeking re-election. Historically, oil and fuel prices have fallen about a month before elections, but if production in the USA decreases while demand increases, this will be quite difficult. Additionally, the USA no longer has the reserves that would be ready for use, although it is not excluded that Biden will find grounds to use them again. Especially since the summer season is starting in the USA, during which demand usually rebounds quite strongly, as indicated by the latest data on products delivered to the market.
Are We Facing Significantly Higher Prices?
It is worth noting that without OPEC cuts, the market would remain in a strong oversupply. On the other hand, a total cut of 6 million barrels per day does not mean that OPEC+ countries would be able to increase production by that much. The production capacities in the OPEC cartel and Russia have significantly decreased in recent years. Nevertheless, producers at this point do not find it profitable to produce more, as this would mean prices as low as 40-60 USD per barrel.
Prices can react to changing geopolitical situations. In the case of a blockade of the Red Sea or a worse situation like a blockade of the Strait of Hormuz, prices could return above 100 USD per barrel. However, this does not seem to be the baseline scenario. Prices of 90 USD per barrel in the first quarter of this year were driven by geopolitical situations rather than the current difference between demand and supply. Moreover, demand in the coming years may not grow as dynamically as in the last 10-20 years (excluding crises), which is related to the energy transition. Electric cars are increasingly appearing not only on American and European streets but primarily in China, resulting in recent demand weakness.
So, are we facing significantly higher fueling costs? In the summer, fuel prices usually rise due to increased demand, but without a sudden increase in oil prices due to geopolitics, we should not experience prices above 7 PLN per liter of gasoline. Furthermore, further fuel promotions cannot be ruled out, which have so far proven to be not only a great marketing campaign but also stations earning significantly more at lower prices than usual.
Author: Michał Stajniak, Deputy Director of the Analysis Department at XTB
