The failure of the Opec + group to secure an agreement on growing oil supplies has pushed it raw prices at its highest level in at least three years.
Brent, the international benchmark, reached $ 77.84 a barrel on Tuesday – the highest point since 2018 – while the US West Texas Intermediate benchmark hit $ 76.98 – the highest since 2014.
Why did Opec + members fall?
The group agrees on the need to raise oil production, as demand has begun to exceed supply. But the United Arab Emirates, one of the most powerful members of the group after Saudi Arabia and Russia, has opposed the extension of a deal reached for the first time in April last year – when oil prices were falling – unless the group agreed to revisit how the production target is calculated.
This might seem like a minor objection when the group wants to increase supply anyway, but the UAE has invested billions of dollars in growing production capacity. He thinks that the so-called baseline used to calculate his production goal is obsolete and does not reflect that new capacity, i.e. it reduces proportionately more supply than other members.
The country’s Energy Minister has said he will stay with his original initial base until April 2022 – the expiry point of last year’s agreement – but cannot agree to extend it further without a revision. Saudi Arabia, normally one of its closest allies, wants the deal extended until the end of next year to give greater clarity to the market.
The UAE has a point. But if the group agrees to review the base of a country, it will feel pressure to do so for all other members of the alliance, and some will not like the outcome.
Russia, not a member of OPEC, has been collaborating with the group since 2016. But it is among the countries that its production destination may fall under such a review.
Tensions are also rising between Saudi Arabia and the UAE, which are increasingly seen as such competitors in the Gulf region.
“The strongest allies not so long ago, the two nations of the Middle East now have divergent views on a number of issues: the war in Yemen, the relationship with Israel or Qatar and the Saudi intention to compete with the ‘UAE as a regional and tourist trading center,’ ’Tamas Varga told PVM oil brokerage.
What’s next for oil prices?
They have already jumped. The group had planned to increase production by 400,000 barrels per day each month until at least the end of this year, adding 2m barrels per day (or about 2 percent of pre-pandemic demand) back to market, gradually removing the ‘enormous 10m b / d cuts accepted in the teeth of the pandemic shock last year.
Without an agreement, the default option is to leave production unchanged, meaning a tighter oil market in the second half of this year as demand picks up. Many banks predict that prices will rise comfortably above $ 80 a barrel – more than 50 percent since January and above where they traded before the pandemic.
The big risk is that if this disagreement remains unresolved, it will undermine group cohesion and lead producers to start ignoring production targets. In an extreme scenario this could even lead to one price war, as in March last year when Saudi Arabia opened the taps after disagreeing with Russia over how to respond to the emerging pandemic.
But Saudi Arabia is likely to prefer a higher price. Analysts close to the kingdom say Riyadh wants to encourage other producers to invest, fearing a supply gap is on the horizon.
Think of this as a Goldilocks strategy. Saudi Arabia wants prices high enough to encourage investment, but not so high that it will accelerate the adoption of renewables and the end of the oil era.
Will a higher oil price encourage other producers to increase their production?
Maybe, but not soon. Major oil companies such as BP and Royal Dutch Shell are below pressure to reduce oil and gas production and invest more in renewables. Investing in large long-term projects – which can have a lifespan of 50 years – seems less feasible when oil demand is projected to peak in the next decade.
But the logjam raises the risk of a faster demand growth of supply before that moment arrives, especially since producers who are not Opec do not intervene to fill the gap. “If it had been another cycle of the last 50 years, non-Opec producers would have reactivated projects and raised the capex orientation by now. Not so on this occasion,” said Martijn Rats, Morgan analyst Stanley.
Eventually, further price increases could encourage U.S. shale producers to “return to swing in 2022,” Edward Morse told Citi.
And the wider market?
The return of inflation has been a current issue in 2021, and a rising oil price is growing in those fears. Gold, traditionally seen as a hedge against inflation, rose 1 percent Tuesday to $ 1,805.71 an ounce.
In addition to putting pressure on consumers, a rising price of oil could also “derail the [US Federal Reserve’s] narrative that most of the current peak in inflation should be seen as transitory, “said Jeroen Blokland, a former analyst at asset manager Robeco. But he warned that Opec + was probably aware of the risks of seeing prices rise too far, disturbing markets.