OPEC’s Shock Move to Tighten Market Leaves Oil World Divided

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When OPEC+ unveiled its bold move to tighten crude markets last week, the oil world was united in surprise. But on the merits of the plan, it’s starkly divided.

The shock decision, steered by Saudi Arabia, to delay again the restart of oil output halted during the pandemic is being lauded by many as a masterstroke of supply management -- and criticized by others as misjudged.

Vitol Group, the world’s biggest trader, said price indicators attest that “OPEC+ have control” of the market. Crude’s rally to a 14-month high is shoring up revenues for the cartel, while spurring Wall Street banks like Goldman Sachs Group Inc. and JPMorgan Chase & Co. to bolster price forecasts.

But others warn that the Organization of Petroleum Exporting Countries risks over-tightening crude markets by denying supplies just as demand recovers, sending prices too high.

It could also encourage a new tide of U.S. shale-oil, Citigroup Inc. says, and turn out to be a mis-step as “counter-productive” as last year’s price war. Or the price squeeze could accelerate efforts to find other energy sources, as in India, a critical customer.

“Withholding barrels as a means of sustaining the price rally will work,” said Bill Farren-Price, a director at research firm Enverus and veteran observer of the cartel. “But in doing so, the table is being laid for a feast at which the U.S. short-cycle operator will be the guest of honor.”

Riyadh has said the surprise move was motivated by “caution,” as the pandemic continues to menace demand. But it’s also bringing rewards for the 23 producing nations that compose OPEC+.

Oil prices soared on March 4 when the coalition, contrary to expectations, announced that it would refrain from restarting 500,000 barrels of daily output in April, and that the Saudis would continue to keep another 1 million barrels off-line. Brent futures soon hit $70 a barrel for the first time in a year.

That brings prices very close to the levels needed -- on paper, at least -- by several OPEC+ nations to cover government spending, data from the International Monetary Fund show.

OPEC’s Shock Move to Tighten Market Leaves Oil World Divided

OPEC’s measures should also speed up its main stated objective -- depleting surplus oil inventories left over during the pandemic. Global stockpiles are set to decline by 58.5 million barrels if the cartel holds output steady in April, according to Bloomberg calculations using OPEC’s data. That’s almost three times the drop that would otherwise have occurred.

With barrels set to become more scarce, prices are showing another trend beneficial for the alliance.

Backwardation -- the premium for prompt oil prices versus later deliveries -- has strengthened in parts of the forward curve.

This can help OPEC by encouraging refiners to burn through surplus stockpiles, rather than hoard them. It can also limit the ability of rivals to finance operations by locking in future prices. The day after OPEC+ met, December 2021 Brent contracts traded $4.27 a barrel above those for settlement the following year.

Shale Gamble

Yet the danger that the rally subsidizes OPEC’s competitors may cancel its benefits.

Riyadh is effectively gambling that shale explorers won’t be able to exploit this boom as readily as those in the past. After years of burning through cash, companies are being compelled to reward shareholders rather pumping profits into more fracking.

“‘Drill, baby, drill’ is gone for ever,” Saudi Energy Minister Prince Abdulaziz bin Salman told a press conference after the March 4 gathering.

Whether shale explorers abide by their new-found sense of restraint will be revealed by weekly rig count data. In the meantime, there are signs the U.S. is gearing up for a recovery.

The nation bolstered forecasts for crude production growth in 2022 by about 70% on Monday, projecting that output will climb by 870,000 barrels a day next year to average 12.02 million a day.

“OPEC+ is throwing reality to the wind,” said Ed Morse, head of commodities research at Citigroup Inc.

Then there are the economic repercussions. Indian Oil Minister Dharmendra Pradhan repeatedly called for OPEC+ to pump more crude, for the sake of both his country sake and that of the fragile global recovery. His pleas were summarily dismissed.

Rising fuel prices could also pose complications for central banks trying to navigate the threat of inflation while using trillions of dollars of stimulus to promote the recovery.

If the market does over-heat, OPEC’s regimen of monthly meetings gives it the opportunity to correct the error at the start of April. With at least 6 million barrels of daily production capacity to spare, the group can quickly revive some of these to cool prices down again.

“OPEC could kill the rally at any point” it chooses, said Neil Beveridge, a senior analyst at Sanford C Bernstein in Hong Kong. “OPEC are now firmly in the driving seat for what happens next.”

©2021 Bloomberg L.P.

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