OPEC faces a moment of truth about planned output increases: Kemp
Saudi Arabia and its OPEC allies will have to make a difficult decision in the coming weeks. They must decide whether they want to proceed with production increases planned for October or postpone them due an uncertain economic outlook. Saudi Arabia and its OPEC?
Recent falls in Brent futures prices for the front-month, calendar spreads, and refinery margins amid concerns over the outlook for oil consumption have highlighted the risk of making a mistake.
The risk of accumulating inventories and falling prices is increased if you increase production despite a downward revision in consumption growth.
Postponing the decision risks losing even more market share in favor of rivals from the western hemisphere and luring some OPEC members to break ranks. Members to break ranks.
Planned Output
Saudi Arabia and the other OPEC members? Members are enforcing a three-part production cut that has been in place since the end of 2022. This is to reduce excess petroleum stocks and support prices.
All OPEC members? All OPEC?
To support the stability of the market, some members will also enforce an additional voluntary reduction of 1,66 million b/d that was agreed upon in April 2023. Another voluntary reduction of 2.2 millions b/d is expected to be agreed upon in November 2023.
In June 2024 ministers agreed that the last voluntary cuts would be unwinding gradually, starting in October 2024.
The United Arab Emirates will also be allowed to increase their output by 300,000 b/d starting January 2025.
According to this plan, OPEC's total production is expected to increase by approximately 180,000 b/d each month in the fourth quarter of 2024 and then by 210,000 b/d each month in the first nine months of 2025. The plan calls for a monthly increase of approximately 180,000 barrels per day (b/d) in the fourth quarter 2024, and then a monthly increase of 210,000 barrels per day in the first nine month of 2025.
Ministers have stressed that the planned production increase is conditional, and can be "paused or reversed" depending on market conditions.
OPEC will decide in the coming weeks whether to proceed, modify or postpone these increases. This is due to renewed concerns about the health of global economy and oil demand. OPEC?
Prices and Spreads
The oil price and spreads have remained the same, or even weakened since November 2023 when the ministers agreed on the second round of voluntary cuts.
Brent front-month futures, inflation-adjusted to the current month have averaged $79 (42nd percentile of all months since 2000), down from $84 (49th percentile) in November 2023.
Brent's six month calendar spread traded at an average backwardation this month of $2.50 (73rd per centile), slightly higher than $1.63 (57th per centile) in November.
The margins at refineries for producing two barrels each of gasoline and distillate using U.S. crude oil have fallen to $22 (43rd%) this month, down from $24 (50th%) in November.
Other price indicators, with the exception of the calendar spreads which are slightly bullish, are in line with the current rough balance between consumption and production.
Since ministers took the decision to increase production provisionally in June 2024, each of these indicators have weakened.
Global Inventories
At the end of the month of June, the commercial stocks of crude and refined product in advanced economies that belong to the Organization for Economic Cooperation and Development totaled 2,761 millions barrels.
The stocks were 120 million barrels below the seasonal average of the past ten years (-4%, or -7.71 standard deviations), and the deficit was almost twice as large in November 2023 (-2%, or -4.44 standard deviations).
According to the U.S. Energy Information Administration's (EIA) data, the deficit has been the largest for nearly two years.
Chartbook: OPEC+ output decision
Since late June, U.S. crude oil inventories continue to fall faster and further than normal, adding evidence to a tightening of the market.
According to the EIA, the U.S. crude inventory has decreased in seven out of eight weeks since the 21st of June by a total 35 million barrels.
As refineries increase their processing to meet the increased demand for gasoline over the summer holiday period, U.S. crude inventory typically decreases in July and August.
The seasonal depletion in this year's harvest was the second largest after 2017 and indicates that global supplies continued to tighten up at the beginning of the third quarter.
On Aug. 16, U.S. crude oil inventories were 9,000,000 barrels (-2%) lower than the ten-year mean, down from an excess of 6,000,000 barrels (+1%) on June 21.
The most significant depletion was at the refineries and tanks in Texas and Louisiana, along the Gulf of Mexico. These are the markets that are the closest to global oil markets.
Gulf Coast crude stocks declined by 25 million barrels in seven out of eight weeks, compared to an average of 10 million barrels over the past decade.
TACTICAL CONSIDERATIONS
Portfolio investors reduced their combined positions in crude oil and fuels by early August to the lowest level since 2013.
On August 13, hedge funds and other money manager held a combined positions in six of the most important futures contracts and options contracts, which was equivalent to only 226 million barrels (third percentile since 2010).
This was down from the recent highs of 524 millions barrels (40th per centile) at start of July, and 338,000,000 barrels (14% percentile) by November 2023.
Fund managers have been reducing their positions due to the increased uncertainty surrounding the future of the major economies, and the global oil consumption.
In what way have they also reduced their positions in anticipation of OPEC? It is unclear to what extent they have also reduced positions in anticipation of OPEC?
Delaying some or all the increase, if it has already been discounted in full, could cause a rapid rise in prices. This would be accelerated and amplified by fund managers trying to rebuild their positions.
Proceeding with the sale of more contracts, if it hasn't been discounted, could cause prices to fall even further.
STRATEGIC CHOICES
The outlook for the world economy in 2024 and 2025 is the underlying theme of all these strategic considerations.
Since April, global manufacturing and freight activity have flattened or weakened. This has led to a much slower growth in petroleum consumption than was expected at the beginning of the year.
It is likely that the U.S. Federal Reserve, as well as other central banks, will lower interest rates in response to economic slowdown to encourage consumer and business spending.
OPEC? OPEC?
It would be prudent to delay some or all of the actions until oil prices rise and the economy accelerates.
The group might decide to go ahead if it is confident about the economy and consumer outlook. It would then dare to prove the skeptics of hedge funds wrong.
Related columns
Oil investors reduce positions to record lows amid financial market meltdown (12 August 2024).
- Oil traders ignore dwindling stock to focus on the economy (8 August 2024)(Editing by David Evans).
(source: Reuters)
