Is Opec Really Banking on Stability?

Opec has increasingly cast itself as the central bank of the oil market, claiming its intervention helps stabilize supply and prices — like other central banks manage the delicate balance between inflation and employment. But markets are not convinced, saying that rather than soothing prices, the producer group fuels volatility and creates an even bigger disconnect with fundamentals, unsettling the wider macroeconomic equilibrium.

The oil rally of late has jacked up Brent prices to $95 per barrel and left the market wondering if Opec’s not the firefighter and the arsonist at the same time. The producer group sees a deficit of 3 million barrels per day in the fourth quarter of 2023. Some may question the claim that it tries to stabilize the market when its own numbers do not show this and when, on top of that, its members keep cutting production. Opec also claims to reconcile the market with fundamentals, when said fundamentals continue to look wobbly and unable to withstand higher prices. Brent futures price spreads over the next six months have widened from 60¢/bbl to $1/bbl per month, not exactly pointing to a poised and stable market.

China Wild Card

Several forecasters — including Energy Intelligence — are still concerned by the discrepancy between China’s oil consumption strength and the steady drumbeat of ominous macro data on the country’s economy. Even the Saudis admit “the jury is still out” on China’s demand, which, coming from the horse’s mouth, sounds nothing short of a bearish statement. China’s economy remains a wild card in 2024, and sharp differences in demand forecasts — ranging from Energy Intelligence’s 370,000 b/d to Opec’s 580,000 b/d and the International Energy Agency’s 640,000 b/d — highlight the uncertainty.

Moreover, China does not like oil prices above $80-$85/bbl and may decide to create a demand vacuum around Opec to cool off prices. It’s not as if Beijing has never done it before. All it takes is lower crude imports. China could import 600,000 b/d less in the second half of the year, Energy Intelligence estimates. The country can tap into record-high stockpiles to keep its refineries well supplied and export refined fuels at full throttle. China has become a swing supplier of petroleum products and is setting global refinery margins almost single-handedly. That’s a lot of pricing power in the hands of one country, maybe not to Opec’s liking.

Demand Slowdown

Equally concerning is the expected deceleration in OECD demand from the fourth quarter, when seasonal effects dovetail with the impact of monetary tightening around the world. Central banks have had to generate a round of negative wealth effects to lower demand, so that it aligns with the new reality of supply. But this is a moving target because Opec keeps cutting production too. For the producer group, selling 10 million barrels at $50 each or 5 million bbl at $100 is the same. But it is not for central banks, because at $100/bbl, they must cope with the effect of higher oil inflation. And what is true for oil is also true for most commodities. This tug of war has put Opec and the US Federal Reserve onto a collision course.

The current thinking among analysts is that the US Fed may pause its aggressive cycle of policy rate hikes if short-term inflation is abating. But the world also now has to deal with the effects of protracted trade wars between the US and China on the one hand, and Europe and Russia on the other. Longer term, this is inflationary for global prices. The more oil and commodity prices increase, the less room central banks will have to cut rates. Any ramp up in demand will almost immediately hit a supply constraint, especially if Opec and other commodity producers tighten their grip on supply.

By likening Opec’s decisions to the benign actions of a central bank, Saudi oil minister Abdulaziz bin Salman may have unwittingly put the same curse on oil producers.

Opec wants this market to run on “just-in-time” supply to protect margins, just like industry has been running on lean manufacturing or central banks on just-in-time liquidity. Over the past nine months, Opec-plus’ 19 members have effectively removed 2.4 million b/d of oil from the market and will continue to withhold supply until at least December. This is a very risky strategy because if demand decelerates in 2024 — as we expect to be the case, Opec won’t be able to bring those barrels back. Looking into next year, Energy Intelligence expects oil inventories to build by 650,000 b/d, even if Saudi Arabia extends its voluntary cuts through the first quarter of 2024.

Tightening Cycle

The central bank comparison also brings two big differences into sharp relief. First, central banks do not obfuscate their inflation target from the market, otherwise, how could the market tell if and when stabilization is achieved? Second, central banks usually try to douse inflation, not the opposite. Describing itself as a “responsive regulator to a market that needs regulating” to a slightly befuddled market felt very much like Opec was indulging a Louis XIV-style, “l’Etat, c’est moi” (I am the state) moment. If anything, the group’s body language tells us that if oil demand isn’t there or if prices fall too much, Opec will pro-actively adjust supply.

Market management is thus by no means over. One could argue that Iranian oil exports, which were up by about 400,000 b/d year on year in July, are also undermining the Saudis’ effort to keep this market tidy. That may force Riyadh to maintain its voluntary cuts in 2024. The last thing Opec wants is a repeat of the massive inventory buildup that accumulated in the first quarter of 2023: it would drag prices back below $80/bbl.

Opec is now pushing hard against the early peak demand scenarios from the IEA, claiming that they are motivated by policy advocacy rather than fact-based forecasting. But the IEA has always advised the OECD on energy policy: It is indeed a policy advocate by design, not a forecaster. If Opec is right that continued investment in oil and gas is a necessary part of the energy transition, maybe it should consider that developing the cheapest oil resources — rather than cutting supply — will be key to future energy affordability. And Opec owns most if not all of those.

Julien Mathonniere is an oil markets economist for Energy Intelligence. The views expressed in this article are those of the author.

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