The Crude Report: Some fundamentals, some geopolitics

Author Argus

While fears of dampening demand from the Omicron variant have seemingly calmed, rising geopolitical tensions are helping to stoke oil prices.

In this episode of The Crude Report, Editor-in-Chief Jim Washer and Mideast Gulf Editor Nader Itayim look ahead to next week’s Opec+ meeting, where ministers look likely to stay the course and sanction another 400,000 b/d output hike for March. 

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Transcript

Jim: Hello everyone, and welcome to this episode of The Crude Report.

My name is Jim Washer. I'm Editor In Chief here at Argus, and with me today, once again is Nader Itayim, our Editorial Manager in Dubai.

So today, we're looking ahead to next week's Opec+ meeting, which takes place against the backdrop of rising oil prices, growing political tensions between Russia, Europe, and the US over Ukraine, but growing confidence also that the Omicron Covid-19 variant is not as dangerous as initially feared. And that the worst of the Omicron wave may, in fact, be over in some countries.

So Nader, let's start with the market situation Opec+ is dealing with heading into next week's meeting. Prices already are at their highest level since 2014, and looking like they could rise further. So what's behind this, and is it likely to continue?

Nader: Hi, Jim, thank you. Yeah, so that's right. Opec+, it heads into these meetings with oil at its highest around 7 years. I mean, it's surpassed last year's highs around $84. As we record this podcast, Brent has crossed the $89/bl mark, and it's really knocking on the door of $90.

In terms of why this is happening, it seems to be down to, like, a confluence of several unfortunate events, shall we say? There are the fundamentals, and also as you say, you know, of course, geopolitics. With respect to the fundamentals, I mean, bottom line is we're seeing tightening balances. On demand, one of the main fears we had, say, two months ago, when we were having this same chat, it was around, you know, the Omicron variant that had just sort of burst onto the scene. There were concerns that it could be pretty severe, and trigger another wave of restrictions, and lockdowns around the world.

And, you know, that would've come all while supply was likely to increase, what with Opec+ continuing to unwind its cuts. But fast forward to today, I mean, those fears, at least, for the most part, they've subsided. Although Omicron has proved to be more contagious, and transmissible than earlier variants, its severity, on the whole, is, you know, much reduced. As a result, we've seen a softer response by many governments across the globe. Although that hasn't really been the case, you know, across the board, it's primarily been in the Northern Hemisphere where, you know, governments are taking a more pragmatic approach, shall we say? And they're really sort of staying away from the kind of serious restrictions and measures that we were seeing earlier in the year...Sorry, early in the pandemic. And yet, you know, in places like China, we're seeing the total opposite. I mean, China is pressing ahead with its, you know, Covid-zero policy, particularly with the Lunar New Year, and the start of the Winter Olympics, just around the corner.

I mean, we're talking about lockdowns and restrictions on movement in some of the country's largest cities and port hubs, which, you know, really is starting to crimp demand. Overall, however, demand is still robust and stronger than expected, and very much on the up. Regarding supply, I mean, within Opec+, we're already seeing several countries in the group struggling to meet their production quotas as dictated by the deal. Some of the usual suspects, Nigeria, Angola, even Malaysia, which ultimately means that the group is, you know, continuing to under-deliver on its pledged 400,000 b/d monthly output editions. According to Argus' own figures, the 19 non-Opec members that participate in the cuts, they delivered 300,000 b/d extra to the market in December. Now, that's just, you know, 75% of the pledge, but you know, several consecutive months of underdelivering, that's left them around, I think 650,000 b/d below their collective, you know, cap for December.

That's a gap that looks set to only grow over the coming months. You know, add to that some unforeseen disruptions and outages in countries that are not participating in the deal say, you know, in Ecuador and Libya, last month, and there's little surprise we're seeing prices as they are. And in terms of geopolitics, I mean, there's been several episodes, some are ongoing, that you'd have to say are contributing to the rising prices. Not least, the ongoing tensions between Ukraine and Russia, where, you know, even if we dismiss the threat of military action, I mean, the possibility of sanctions alone on Russia could represent yet another risk to world supply. Beyond that, we've seen, you know, the Houthis in Yemen. They've stepped up their attacks in the region. I mean, most recently to the UAE which has been a target of two separate ballistic missile, and drone attacks in the past two weeks. I mean, that's effectively opened up the whole new front in the ongoing Yemen War. You know, the Houthis, they were previously only really focusing their attacks on Saudi Arabia, and on shipping through the Bab al-Mandab strait. So all in all, I mean, I'd say, it's difficult to see anything other than oil prices continuing to move up over the coming weeks and months. I mean, there certainly doesn't seem to be anything obvious that would cause, you know, the oil prices to fall.

Jim: Okay. That's a lot for Opec to think about. I mean, so how worried are they about all this? How worried are they about these rising prices?

Nader: Well, from what we've been seeing and hearing over the past few weeks, I think the answer to that is, you know, yes, it is a concern for Opec+, but also no. Yes, in that oil prices at, or around the $100/bl mark, I mean, they're not good for anybody. Oman's oil minister, Mohammed Al Rumhy, he said earlier this month, or earlier in January, that Opec+ as a group doesn't really want to see oil at a $100/bl. I mean, he said the world is not really ready for that. He pointed to the fact that Opec and its non-Opec partners, they're now meeting on a monthly basis, and that sort of allows them to keep their hands firmly on the, you know, proverbial wheel, and stop the market from overheating. Other Opec delegates that we've spoken to, they also said the same.

But why I also say no here is that there doesn't really also seem to be an overriding sense among these delegates that at least for the moment that something needs to be done about it, or hang on...Sorry, let me rephrase. There's something that they need to do about it. You know, I mean, why do I say that? These delegates that we've spoken to, several of them have pointed out, you know, to a very... They've pointed a very clear geopolitical element in the price rise. They admit that yes, fundamentals have played a part in the prices rising, you know, supply tightness concerned over future spare capacity and such, but, you know, that alone, they say that this doesn't explain why the prices are where they are, you know, at around $90. They feel that, you know, the concerns over supply disruptions, either because of what's happening in Russia and Ukraine, or in the Middle East. I mean, they feel that's sort of more to blame for the trajectory of the price at the moment, particularly, when you consider the importance of these countries. I mean, Russia and the UAE in Opec+, and because of this, I mean, because of this geopolitical element, there's a feeling that, you know, this really isn't their problem to fix, you know, as was the case, you know, when prices were last in the say eighties in October. At that point, they didn't feel the market was necessarily in deficit for them to, you know, produce more. So, I think the same can be said for now. So, at least for now, I think the sense is that, it's better to wait it out.

Jim: Okay. So perhaps from the sound of it, we shouldn't really expect them to do too much to counter this, but is this really a question of what they want to do, or what they can, or cannot do?

Nader: Right. So that's an interesting question, essentially, you know, can the group do more than the 400,000 b/d in any one month if needed, right? I mean, in theory within the confines of this deal, you'd have to say, no. Now, why? That's because the agreement essentially only really allows them to increase production by, you know, a maximum of 400,000 b/d, each and every month through to April, and a maximum of 432,000 b/d, every month beyond that through until September assuming that the group, you know, doesn't really choose to pause these hikes in any one month. But when you look at the numbers a little bit more closely, as I mentioned before, you know, we see that Opec+ as a group, they've in many months really been falling short of actually delivering that 400,000 bls per increment. As a reminder, you know, what did we say in our last August production survey?

I mean, we found that the countries that are participating in the deal, only delivered three-quarters of the 400,000 b/d that they pledged to add, as several countries, you know, kept their output below their ceilings. In some cases, you know, as with Saudi Arabia, for example, sure. I mean, this is intended, but in many other cases, such as, you know, with Nigeria, Angola, Equatorial Guinea, Congo, I mean, this is more down to an inability to produce more. I mean, typically, for operational reasons, which are in most cases pretty persistent. I mean, that left the group 650,000 b/d below their collective cap in December. And as the group continues to unwind the cut, I mean, this problem is only going to get bigger as more and more countries begin to struggle with, you know, the same thing. So, I mean, what now? So far, several Opec ministers have dismissed the suggestion or the notion that, you know, those countries with spare capacity.

So, you know, the likes of Saudi Arabia, UAE, for example, I mean that they could compensate for those who are not really able to deliver their own shares of the cuts. They say that, you know, it's every country's right to decide whether to produce that quota or under, and it would essentially be against the spirit of the deal to encroach on another country's quota. That's fair, but I'd argue personally that, you know what? I mean, Opec+ and Opec before it, they've always found ways around such things in the past, in the sense that, you know, when needs must, they've always been able to tweak the rules, rejig the deal, essentially do what's necessary, and there is precedent for this. In the middle of 2018, for example, there was a point when there was, you know, huge over-compliance by the group as a whole, in that several countries were cutting just too much, and in many cases, you know, due to reasons that were really out of their control. At that point, the group then decided, you know, those countries with capacity should produce more to compensate for the countries that weren't able to fulfill their own quotas.

Admittedly, if such a plan were to be put on the table today, it wouldn't be that popular, you know, with many countries, and the group still having, you know, some room to go before they reach their capacity. But further down the road, several months down the line, you know, when a number of more countries are at or close to reaching capacity, I don't think it's beyond the realms of possibility that they, once again, you know, revert to that kind of an arrangement, if the market is clearly in deficit. So, you know, I'll repeat something I've said many times before, Opec+ and Opec before it, it's nothing if it's not flexible.

Jim: Okay. So next week's meeting, let's get into some specifics here. We've got all the sort of backdrop in the sort of the kind of Opec rationale here. What do you think is going to happen next week?

Nader: Right. So, in terms of the coming meeting, I mean, what we're hearing from delegates is that we should really be expecting more of the same. I'm sorry to say this. It feels like I'm doing it every month, but I mean, it feels like we're going to get another continuation of the plan, you know, as is, and in agreement to sanction yet another 400,000 b/d increase in the overall quota for March. And that's really for many of the reasons that I laid out a little earlier. I mean, first, again, that there isn't really a feeling at the moment that the market is necessarily in deficit and in need of more crude, but also because really a decision to raise quotas by more than 400,000 b/d at a time, the group is already struggling with that volume, or to bring on that volume every month. It would really only end up putting more pressure on the group. So, you know, that said though, of course, you know, with prices being as high as they are at the moment, you can never discount some 11th-hour pressure being placed on the group from Washington to, you know, do more, but save that, I think we're all set for yet another quick, and straightforward meeting this month, which to be honest, it may not be such a bad thing, given how complex things are, you know, likely to start looking very soon. These short and sweet meetings, they may become a thing of the past.

Jim: Soon become a thing of the past. Now, that's rather intriguing. So, why is that? What's on the agenda in the next few months?

Nader: Yeah, sure. I mean, there's many things to look forward to, but there's one thing in particular that, at least, I personally find could, you know, cause a little bit of intrigue, confusion, possibly even a bit of tension as well. It's this idea, or this decision to issue new higher baselines for five of the Opec+ group's members, that's gonna soon come into effect. I mean, if you remember the group in mid-2021, so they agreed to issue new higher baselines to five countries. So, Saudi Arabia, Russia, the UAE, Kuwait, and Iraq. This all started after the UAE was pushing for higher baselines in exchange for, you know, an agreement to extend the deal beyond the original April 2022 expiry. In the end, after a lot of toing and froing, they got given this higher baseline, but that also came with higher baselines for four other countries.

Now, in these new baselines that were agreed, they amounted to a cumulative of 1.6mn b/d, and they will take effect essentially from May 2022 through, until the end of the year. So, in the days and weeks following that agreement, there was some confusion among delegates as to what impact that would have come May. There were some delegates who said at the time, and who still say today, that this could actually, you know, translate into a 1.6mn b/d hike in May to actually reflect the change in baselines, but others have repeatedly insisted to us, you know, and publicly that this isn't really the case. They've said that, you know, the purpose of the change in the baselines was essentially to, basically, protect these countries in the event that new cuts are agreed in the future, in the sense that they would really have to cut from a higher baseline. For what it's worth, as of now, we, at Argus, we're of the understanding that the change will not, essentially, translate into an additional 1.6mn b/d of supply. But with some delegates still unsure, I'd say it's certainly one to watch.

Jim: Okay, well that certainly will be, I think, the intriguing issue for the next few months, that is quite a volume, well, but as you say, far from clear that that's really what that means. Okay. Well, Nader, thank you for your time today. That give us a good sphere on what to expect next week.

If you wanna keep up to date with our in-depth, Opec news and analysis, then why not subscribe to Argus Global Markets or Petroleum Argus, or indeed both. You can find more information on these services at www.argusmedia.com. So, thanks for tuning in, and we look forward to you joining us on the next episode of The Crude Report.

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