OPEC Deal Crumbles, Oil Prices Continue to Rise

On Thursday and Friday of last week, OPEC and its allies convened in Vienna to discuss their strategy for oil production over the coming months. This meeting was scheduled to address the increase in demand for oil surpassing the increase in oil supply. In fact, this shortage of production resulted in U.S. inventories of crude oil, including the Strategic Petroleum Reserve, falling at around 1.15 million barrels/day over the past month, which is the largest stockpiles have fallen in a four-week period since 1982.¹

Geopolitical unrest was always a concern heading into this meeting. In March of 2020, Saudi Arabia and Russia began an oil price war. In this race to the bottom, U.S. oil futures fell to below $0/barrel last April and Brent futures fell from $70 to $15 per barrel.² The conflict was ended in part by former President Donald Trump’s intervention, as the U.S. threatened to cut ties with Saudi Arabia unless they began to cut oil production. Furthermore, nuclear sanctions prevent Iranian oil from returning to the market. Iran’s oil minister claims that his country can raise its crude production up to 6 million barrels/day, a high that has not been reached since the 1970s, from its current output at 2.5 million barrels/day.³

Prior to the meeting, analysts estimated that OPEC would increase its target production capacity by 500,000 barrels/day for the month of August and promise further oil supply increases in subsequent months.⁴ At the start of the meeting, OPEC seemed close to agreeing to increase supply by 400,000 barrels/day each month from August to December.⁵ However, on Friday, the United Arab Emirates refused to sign off on a proposed deal that had been accepted by all other OPEC members. Talks were postponed to Monday before being completely called off.

UAE and Saudi Arabia Clash Creates Uncertainty

Saudi Arabia and the UAE are locking horns over production. The UAE wants to boost their own baseline production quota to reflect their actual capacity to produce more oil. This would allow the UAE’s total output levels to more closely compare with that of heavyweight Saudi Arabia. It was for this reason that the UAE did not agree to the deal, which would have maintained their current capacity quota through 2022.⁶

Saudi Arabia, meanwhile, voluntarily cut their own production at the start of the pandemic, even further than the OPEC+ alliance’s agreed production cut, to prevent oil prices from falling. The alliance is currently producing an estimated 37 million barrels per day, compared to 43 million barrels per day at the start of the pandemic.⁷

Competitive interests between Saudi Arabia and the UAE don’t stop at production capacity, either. Geopolitical relations between the two countries have been strained in recent years, and many saw it as only a matter of time before those conflicts spilled onto the OPEC negotiating table. In 2019 the UAE pulled its forces from a Saudi-led coalition fighting in Yemen. Then, in September 2020, a peace agreement between the UAE and Israel created a divide within Saudi Arabia’s royal family. Most recently, Saudi Arabia has been negotiating with Qatar (an adversary of the UAE) after a U.S. negotiated truce.⁸

As of this writing, there is no date for the alliance to host their next meeting. A transparent and efficient production schedule can bring oil markets back to equilibrium. But, until the alliance can come to an agreement, markets are reflecting the high demand expectations and uncertainty in supply.

Impact on Markets Still Unclear

The markets had two interpretations on how to price oil following the OPEC meeting. WTI continued to rise rapidly from Friday to Tuesday morning on the news that OPEC was unable to reach an agreement, removing any possibility of an output increase in the interim. WTI futures, as of Tuesday morning, were trading at prices last seen in November 2014 ($76.98), representing a 57% gain YTD. Brent Crude also recently hit its highest level since late 2018 ($77.16). However, by market close on Tuesday, WTI ended down 2.4% ($73.31) and Brent ended down 3.4% ($74.53) on the day.⁹ This reversal might signal the expectation of OPEC negotiations ending amicably and oil supply increasing sooner rather than later.

The bullish case for oil is that the existing tapering of oil production is maintained, and thus the current output schedule continues through April 2022. This has the potential to result in an even higher surge in oil prices, an expensive proposition for consumers and governments alike. Rising oil prices would eventually impact the demand, which is important to the current economic recovery. The sentiment of rising inflation would likely continue to grow louder without a deal, as prices rise.

The most bearish alternative would be a price war across the different countries that make up the OPEC+ alliance. If the OPEC+ alliance can’t come to an agreement on capacity distribution, the result would be exporters flooding the market with oil and reversing the current upward trend in oil prices. This scenario would greatly impact supply volatility and is certainly one the alliance would prefer to avoid.

If oil prices continue to rise, it may also impact the timeline of Central Banks deciding whether (or when) to tighten monetary policy. Emerging markets are more sensitive to price pressures, since oil imports make up a greater percent of their total GDP.¹⁰ With rising prices, oil exporters would see currency appreciation, while importers would see their currencies depreciate on a relative basis. This could further impact multi-national corporations with exposure to foreign markets.

We hold out hope for stabilized pricing and are keeping an eye on the absolute level at which prices settle, as a long-term increase could contribute to the sticky inflation that we believe is on the way. We believe that central banks are unlikely to tighten monetary policy in the immediate term given the fragile state of the global recovery and the spread of and uncertainty around the Delta variant. Short-term reactions appear to be knee-jerk; we prefer the long game. We remain overweight on energy in our portfolios.

Performance of WTI Crude vs. 10 Year Treasury (YTD)

Performance of WTI Crude vs. S&P 500 (YTD)

Stephanie Link: CNBC TV Schedule

Sources

1. Javier Blas, Chief Energy Correspondent, Bloomberg
2. Reuters, "Trump told Saudi: Cut oil supply or lose U.S. military support", April 30, 2020
3. Bloomberg, "Iran Says It Can Quickly Boost Oil Output if Sanctions End", July 4, 2021
4. CNBC, "Oil prices could skyrocket if OPEC+ fails in pledge to deliver more supply", June 30, 2021
5. CNBC, "OPEC+ ends Friday’s meeting without a deal, to seek agreement Monday on oil output policy", July 2, 2021
6. Bloomberg, "OPEC+ Deal Fails, Leaving Oil Market Tighter as Prices Surge", July 5, 2021
7. AP News, "OPEC oil alliance at impasse between Saudi Arabia and UAE", July 5, 2021
8. Wall Street Journal, "In OPEC Deadlock, U.A.E. Steps Out of Saudi Shadow", July 5, 2021
9. CNBC, "Oil touches six-year high after OPEC fails to get deal, then turns negative", July 6, 2021
10. Reuters, “Oil turmoil reminds markets of inflation pain points”, July 7, 2021
11. (Charts): FactSet

Disclosures

Investment Solutions at Hightower Advisors is a team of investment professionals registered with Hightower Securities, LLC, member FINRA/SIPC, & Hightower Advisors, LLC a registered investment advisor with the SEC. All securities are offered through Hightower Securities, LLC and advisory services are offered through Hightower Advisors, LLC. This is not an offer to buy or sell securities. No investment process is free of risk and there is no guarantee that the investment process described herein will be profitable. Investors may lose all of their investments. Past performance is not indicative of current or future performance and is not a guarantee. In preparing these materials, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public and internal sources; as such, neither the information nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Hightower shall not in any way be liable for claims and make no expressed or implied representations or warranties as to their accuracy or completeness or for statements or errors contained in or omissions from them. This document was created for informational purposes only; the opinions expressed are solely those of the author, and do not represent those of Hightower Advisors, LLC or any of its affiliates.