OPEC and allies will focus on fundamentals

OPEC+ meets at the end of March and is likely to endorse plans for another moderate increase in oil production. From May 2022, new higher baseline levels will take effect for several producers in the alliance and according to OPEC+ calculations, an additional 430k b/d will be added on a monthly basis, compared with the 400k b/d that has been the monthly target since Q3 last year. Among those benefitting from higher baseline levels are Saudi Arabia, the UAE, Kuwait and Russia.

Messaging from OPEC+ ministers has been consistent that they will not willingly oversupply markets even as importing nations call for higher production levels in response to the challenges in accessing Russian supply caused by the country’s invasion of Ukraine. The UAE’s energy minister, Suhail al Mazrouei, said at an energy event in Dubai earlier in the week that OPEC+ “won’t add resources if the market is balanced” and if “resources are in the market.” Russia is still able to export crude and products, in the sense that its logistics capabilities have not been damaged by the war, and the country has been sending cargoes to importers in Asia. However, sanctions from the US, EU, UK and others are affecting payment for the cargoes as well as the logistics behind the trades (arranging freight, insurance, finance etc).

Russia of course remains part of the OPEC+ alliance so any proposal to increase production that would come at its expense would threaten the integrity of the bloc of exporters. OPEC has historically been able to separate political issues from oil market management; witness for instance that both Iran and Iraq engaged with OPEC during the peak of their conflict in the 1980s. With sanctions on Russian oil and product exports at their core a political issue, we would expect OPEC+ to keep its focus squarely on its interpretation of oil market fundamentals. Indeed, a go-slow approach to production increases may now look warranted given that China is dealing with some of the worst Covid outbreaks since the pandemic began, this time affecting major centres of the economy and causing a near-term drop off in oil demand.

The spike in spot prices in the first three months of 2022, as well as the historically wide backwardation in timespreads shows the market pricing in a substantial shortage in the market, even if technically it has not materialized yet. We expect OPEC+ will continue to push against the narrative of a tight market as bilateral and multilateral sanctions, whether on Russia, Iran or Venezuela, contribute to the relative inaccessibility of crude oil and products. Should a material supply shock occur—an actual disruption to physical supplies—then OPEC+ would probably endorse higher output levels.

Our target for Brent futures in Q2 is USD 120/b on average and for WTI at USD 115/b. The ‘perceived’ shortage is likely to become more and more apparent in coming months, helping to keep prices elevated but we do expect considerable volatility based on geopolitical and economic headlines as well as a considerable drop in futures markets volumes.