After a few days of wrangling and intense diplomacy, OPEC+ reached a consensus decision last Thursday about its near-term policy. Undoubtedly, negotiations were tough given that countries highly dependent on oil revenues to balance their budgets have been hit particularly hard during the pandemic due to the collapse in the price of oil, and are looking to rebound as soon as possible. Ahead of the OPEC/OPEC+ meetings last week consensus was a three-month delay to the tapering of production cuts.
Ultimately, OPEC+ agreed to increase production by 0.5 million barrels per day (mb/d) in January 2021, with subsequent monthly adjustments based on market conditions. The OPEC+ ministers are to meet monthly, and the magnitude of production change can be up to 0.5 mb/d in either direction. The deal also requires members that are currently less than 100 per cent compliant (since the deal started in May) to make up for their under-compliance by end March 2021. This extends the deadline for catch-up cuts from year-end, and was important for getting UAE in line.
This implies that OPEC+ is moving to a micromanagement of the oil market, albeit the very impressive OPEC+ compliance is expected to commence to fade somewhat going forward as compensation for countries close to 100 percent compliance starts to end.
After the adjustment of the OPEC+ agreement, the expected fundamental oil market balance for Q1 2021 ends up as neutral, with an insignificant undersupply of 0.02 mb/d according to industry experts. This implies limited upside potential for oil prices in the short term amid still-inflated oil inventories and a continued high level of OPEC+ spare production capacity, and an oil price which has recovered somewhat from its pandemic lows.
The outlook for the second half of 2021 is somewhat different though, as the oil market balance could end up undersupplied, with sharply eroding implied OPEC+ spare production capacity as global economies come back online following Covid vaccination roll-outs. These are the two key arguments for a more bullish oil price by the end of 2021.
Oil demand in emerging markets continues to improve. While there has been much focus on the re-imposed lockdowns in Europe and accelerating coronavirus in the US, oil demand in emerging markets continues to improve.
Bloomberg’s daily activity indicators reveal that emerging markets and advanced economies have followed each other closely in the recovery since the trough in April. However, since the start of October we have witnessed a diverging trend. From an oil demand perspective this diverging trend is very important, and we need to remind ourselves that emerging markets consumes more than 50 per cent of total global oil demand.
China’s oil demand is back above pre-pandemic levels, and back to longer-term trend growth. India recorded year-on-year (YoY) growth in October for the first time since February, and mobility data indicates that Brazil is also back in positive territory YoY.
Recent data reveals that mobility in Europe has held up rather well during the second round “lighter” version of lockdown restrictions. The use of cars has been hit much less than in March/April. In addition, trucking activity in Europe seems unaffected by the re-imposed lockdowns, in contrast to what happened in March/April.
Analyst oil price estimates are unchanged. There is an expectation for limited upside for the oil price in the short-term amid still-inflated inventories and ample OPEC+ spare production capacity. However, moving into the second half of 2021, depleted global oil inventories combined with significant erosion of implied OPEC+ spare capacity could result in significantly higher prices, potentially reaching 60 USD/ bbl by the end of 2021, should events unfold according to OPEC’s expectations.
Disclaimer: This article was written by Simon Psaila, investment manager at Calamatta Cuschieri. The article is issued by Calamatta Cuschieri Investment Services Ltd, which is licensed to conduct investment services business under the Investments Services Act by the MFSA and is registered as a Tied Insurance Intermediary under the Insurance Distribution Act 2018.
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