As OPEC+ headed into the JMMC meeting held yesterday in Vienna, Brent prices nudged back above $70/bbl. Brent, back to the highs seen back in March when Saudi Arabia surprised the market by holding off the production increase for two more months. This caught the market by surprise which caused oil to squeeze up to $70/bbl. only to then fall back down to $62/bbl. After seeing dismal prices in Q1 2020, even negative prices in April, OPEC+ must be airing a sigh of relief.
They have done a great job in getting the price of oil to revert back to its mean before the pandemic hit, but the bigger question is, are they going to get greedy and let the market get too tight over the summer?
One of the biggest reasons why the oil price - unlike say other commodities like copper, iron ore and steel - has rallied from March 2020 lows is because the majority of supply has been taken off the market since last year. OPEC+ has managed to keep about 8-9 mbpd of oil out of the market since the production cuts last year, buying time, until demand fully recovers before returning those barrels back onto the market.
Now this inventory picture is very different compared to iron ore and copper, where literally the demand surge from infrastructure spending and EV boom has overtaken supply for the time being, causing prices to rally much higher.
Oil has lagged but for good reason, there is no shortage of it, it is just being held back in a timely fashion to support the market. Going back to the demand side, it is recovering to pre-COVID levels but we are still about 5-6 mbpd shy of where it was prior to the pandemic. Certain products are faring much better like gasoline vs. others like distillate which are dependent upon on travel demand and jet fuel.
Given the lockdown restrictions still in place across the board, travel is nowhere close to going back to where it was any time soon despite all the vaccinations. Airlines are charging higher fares and governments are even stricter with their travel procedures and quarantine measures, making it impossible for people to travel even if they wished to. In addition, China was quite shrewd in picking up oil back when it was trading below $40/bbl. Brent, is now holding back on its imports as prices nudge towards $70/bbl. As and when travel demand does resume, dependent upon economies being able to withstand the COVID variants, time will tell how quickly jet fuel demand can recover.
OPEC+ met yesterday to keep the existing production release agreement in place which sees about 350 kbpd of oil return in May and June, and 400k bpd return in July along with Saudi's extra 1 mbpd of the voluntary cut. This comes at a time when summer demand is picking up so this supply increase can carefully match the demand pick up for now. U.S. oil companies are certainly holding off on drilling too soon too fast. Most that have the capital to do so are ramping up, but the big majors are getting a lot of pushback on their ESG standards and emission targets. Their commitment to diversify into "greener" fuels away from traditional capex spending implies that we may see slower growth in the future even if prices were to nudge higher.
Then again, oil majors are never quick to react, we see this in BP (BP) , that only after oil hit $40/bbl. has diversified its strategy to renewables away from oil and gas, selling low and buying high! One can argue that U.S. production has lost a good 2mbpd of oil for now, and will need to see much higher prices for longer before we see any recovery, than just maintaining its 11 mbpd of oil production for now.
The Iran deal is off the table for now, but talks will resume in August. It seems a deal will want to be reached sooner than later, and even if so, that oil will come back slowly onto the market, which is a potential risk for the latter half of the year.
Most of the sell side analysts are pushing for long oil here as the catch up "value" trade with prices nudging higher towards $80-$85/bbl. Brent. That is entirely possible if demand fully recovers in the next few months with supply still being slow to catch up, lest they go on the same spending spree as before.
The bigger issue is how much and how soon will OPEC+ want to release that extra oil as demand picks up. It seems they want to err on the side of caution as they cannot afford lower prices. This presents another issue, if they wait too late to release this extra supply prices can squeeze much harder, eventually choking off demand as the consumer will not be able to afford gas prices at the pump. The more prudent approach would be to keep releasing more oil production over the summer that can match the increasing demand allowing oil to move up gradually.
The fact of the matter is that the oil cycle is anything but in a super cycle. There is no shortage of oil, it is just a timing game. Eventually demand growth will peak as alternative fuel sources and renewables take over in the next few years, but we can still get periods of tightness in between. All eyes on economies reopening and travel resuming vs. when OPEC+ decides to open the valve and release supply (no pun intended). It is best not to be too greedy, but then again, they can be forgiven for that given their budgets rely heavily on oil revenues still in the near term.
