Oil faces a perfect supply-side storm that will shake up prices

The result of the OPEC meeting has been a bomb

Volatility has gripped the oil market since mid-March. After having rebounded more than 200% from the lows of 2020, it now faces a turbulent future, with conflicting forces (supply and demand) and expectations that vary almost daily due to news about the evolution of covid-19, the OPEC pacts and other negotiations.

On the one hand, a strong demand boom is expected, driven by the economic recovery. But on the other hand, on the supply side, OPEC and its allies are expected to increase production, at the same time that the US fracking industry resumes operations, while Iran could return to international oil markets. Where the price of crude will go is a mystery, what seems clear is that curves are coming and that volatility has come to stay for a while, they say from the German bank Commerzbank.

A turn in weeks

At the beginning of March, Brent oil, the benchmark in Europe, reached $ 70 for the first time in more than a year. The narrative was clear: the economic recovery was gaining momentum, while the supply of oil remained limited by OPEC cuts, the exclusion of Iran from international markets and the difficulties of the US oil industry to return to producing crude at levels of 2019.

However, this entire supply-side scenario has radically changed in a matter of weeks, while the expected boom in demand could be delayed or may not be strong enough to offset the higher crude production. All this has slowed down the oil rally that is now moving between $ 62 and $ 65 per barrel, when in March some analysts had already begun to talk about a possible rise (in any case temporary) to $ 100 a barrel and of a new oil supercycle.

ING analysts Warren Patterson and Wenyu Yao say developments on the supply side have not helped. The US and Iran are going to participate in talks together with the EU, China and Russia to try to save the nuclear deal . “Although it is unlikely that there will be a breakthrough at this week’s meeting and thus a rapid lifting of US sanctions, the talks appear to be moving in the right direction for the eventual lifting of the sanctions.”

Thus, the market is considering the potential return of Iranian supply sometime this year. To this must be added the recent decision by OPEC +, which is finally beginning to ease production cuts, “so there is potentially a significant amount of oil supply that will return to the market in the coming months,” these experts say.

“Like a bomb”

A strong increase in crude production (supply side) is looming in the short term, especially after the surprise that occurred at the last meeting of OPEC and its allies. Virtually everyone expected the cuts to continue (about 8 million barrels per day or mbd), but “the meeting ended with a bomb: the group agreed to significantly (although gradually) increase production in the next three months,” they explain from Commerzbank.

The OPEC + oil supply is forecast to increase by 350,000 barrels per day in May, another 350,000 in June and another 450,000 barrels per day in July. At the same time, Saudi Arabia plans to gradually reduce its additional voluntary cut of one million barrels per day that has been in place since February, increasing its production by 250,000 barrels per day in May, 350,000 in June and 400,000 in July. Viewed another way, OPEC + supply will increase by a total of 2.15 million barrels per day in July.

“This could lead to a new oversupply in the oil market and would initially mean abandoning the stated objective of eliminating high levels of crude inventories. One can only speculate on what might have happened at the meeting. However, a one thing is clear: there was a phone call shortly before between the energy ministers of Saudi Arabia and the United States, “the Commerzbank experts clarify. The US would have asked OPEC to reduce production cuts so that the price of oil remains relatively cheap and provides more support for the global economic recovery, which in the long term will also be positive for oil producers, since they will be able to export more crude as economic activity recovers.

But it is not only the offer. Some demand factor has also weighed on crude oil in recent days, although in this case it could be a only temporary drag that affects market sentiment: “There are several factors that contribute to this most recent weakness. First, the Concerns about COVID-19 infections continue. We’ve seen several countries impose or extend COVID-19-related restrictions recently, while in India COVID-19 cases hit record highs over the weekend. this raises concerns about demand, given that at this time a large part of the constructive outlook for the oil market is based on the assumption that we see a strong recovery in demand during the second half of this year. “

Despite everything, there is some optimism. Oil will live troubled months , with very high volatility. “However, we believe that, even with additional supply from OPEC + coupled with higher Iranian production, the market will continue to reduce inventories throughout the year, pushing prices higher throughout 2021,” they say the economists of ING.

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