The Fuse

Oil Prices Hit Highest Level Since 2019 as OPEC+ Regains Control

by Nick Cunningham | June 02, 2021

OPEC+ decided to stick with its plan to add some oil back onto the market in July, citing rising global demand.

The group, by holding back extraordinary volumes of oil since the beginning of the pandemic, has erased a global supply glut and has helped drive oil prices up to a two-and-a-half-year high. With high oil prices and light at the end of the pandemic tunnel, OPEC+ is firmly in the driver’s seat, at least for a while.

OPEC+ adds supply, keeps large cuts in place

“Covid-19 is a persistent and unpredictable foe, and vicious mutations remain a threat,” OPEC Secretary-General Mohammad Barkindo said.

But at a technical committee of the OPEC+ group met on Tuesday, the OPEC+ coalition sounded a note of bullishness, pointing to a rebound in global oil consumption. OPEC+ estimates that oil demand will rebound by 6 million barrels per day this year.

As a result, they quickly agreed to proceed with releasing an additional 841,000 barrels per day (b/d) back onto the market in July – the 30-minute meeting was noticeably short by OPEC+ standards, pointing to a sense of cohesion on their current course.

“The demand picture has shown clear signs of improvement,” Saudi Energy Minister Prince Abdulaziz bin Salman said, but he cautioned that it’s not clear that much larger increases in supply are needed at the moment. “I will believe it when I see it,” he said.

OPEC+ said it would stick with July production levels through the end of the agreement, which lasts through March 2022, although they can make changes along the way if needed.

The one variable that everyone is watching is what happens with the U.S.-Iran negotiations.

The one variable that everyone is watching is what happens with the U.S.-Iran negotiations. The two sides are inching close to a deal that could restore aspects of the 2015 nuclear agreement and lead to the removal of sanctions. Iran could return roughly 1.5 million barrels per day of sidelined capacity.

Iranian officials said a deal could be reached by August, undercutting growing speculation that a deal was near in June. “We’re close to an understanding over principal, nuclear issues,” Iranian government spokesperson Ali Rabiei told reporters, adding “some differences such as Trump’s sanctions and Iran’s measures need to be worked out.”

Not coincidentally – with OPEC+ stating that demand is on the rise and Iranian oil delayed for a bit longer – Brent crude surged above $71 per barrel on June 1, the highest price in over two years.

Demand is not back to pre-pandemic levels, but oil prices are now higher than at any point since early 2019.

OPEC+ regains control

For much of the past year and a half, the historic buildup in crude inventories left a major overhang, and the market narrative revolved around oversupply and how long it would take to drain off the surplus. That has now occurred (and likely occurred weeks ago), and the narrative has suddenly flipped to by how much the market will be short on supply later this year.

“In the absence of changing the policies, with the strong growth coming from the U.S., China, Europe, we will see a widening gap” between demand and supply, Fatih Birol, the head of the International Energy Agency said, according to Bloomberg.

Another part of the bullish narrative is the ongoing drilling restraint in U.S. shale, and also a broader shift in corporate strategy among the oil majors, imposed on them by shareholders. Cuts to capex and drilling removes the threat of new supply overwhelming the oil market, as the shale industry did multiple times over the past decade.

“The bull recipe for the oil market is still intact: reviving demand, muted U.S. shale oil response together with controlled and restrictive supply from OPEC+, resulting in further declines in inventories and yet higher oil prices,” said Bjarne Schieldrop, chief commodities analyst at Swedish bank SEB.

“Demand euphoria is still receiving daily doses of reality as Covid-19 cases are boundlessly spreading in India and other parts of Asia.”

There are, of course, caveats to this thesis. Rystad Energy cautioned in a note that oil demand still faces roadblocks from Covid-19, despite successful vaccination campaigns in North America and parts of Europe. “The prevailing market expectation is that oil consumption will outpace supply by summer, but the demand euphoria is still receiving daily doses of reality as Covid-19 cases are boundlessly spreading in India and other parts of Asia,” Louise Dickson, oil market analyst at Rystad, said in a statement. “Partial lockdowns are in place through June in key economies such as Malaysia, Indonesia, the Philippines, Thailand, Vietnam, Japan.”

But leaving aside the pandemic, the publicly-traded western oil companies are increasingly hobbled by debt, shareholder demands, and growing societal pressure to slash emissions. The energy transition is suddenly underway and low-cost state-owned producers, particularly those in the Middle East, will be left in a stronger position than their publicly-traded counterparts in the West. If and when global oil demand is eroded by the clean energy transition, it will be done on the backs of higher-cost producers.

“In the brave new energy transition world, we may see price cycles in the future we have never seen in the past, but the surplus of global readily available economical oil volumes, especially spare capacity from OPEC+ heavyweights like Saudi Arabia, Iraq, Kuwait, etc., will step in to fill the supply gap,” Dickson said.

At the same time, the energy transition poses existential risks to the petrostates as well. In a separate report, Rystad Energy said that global oil and gas tax revenues could hit $975 billion this year, but will never again come close to the $1 trillion mark.

“As the energy transition ramps up, countries highly dependent on tax revenue from the upstream industry may have no other option than to diversify their economy to sustain state budgets,” said Espen Erlingsen, head of upstream research at Rystad Energy.

For now, OPEC+ will celebrate higher oil prices and more leverage over the market, but the energy transition will eventually come for all oil producers.