Swissquote Bank: The OPEC drama

July 5, 2021

By Ipek Ozkardeskaya, Senior Analyst at Swissquote Bank

The OPEC+ meeting is turning into an OPEC+ drama, as oil producer countries can’t find an agreement on whether they should extend the actual production-cut agreement into next year.

According to the latest news, OPEC+ countries have reached an agreement to increase production by 400’000 barrels per day starting from August, to meet the increasing global demand with the reopening of economies, increased economic activity and traveling.

But Saudi wants to extend the production-cut regime to the end of next year to make sure that another wave of contagion doesn’t spoil the more-than-a-year efforts that were put in to deal with the pandemic from all OPEC+ members in restricting their oil output.

Russia agrees to follow Saudi in this plan, but the United Arab Emirates is blocking the deal, insisting that it’s not a decision to be taken right now. More importantly, they ask for better conditions for the UAE, with the threat of leaving the cartel if their demand is not met.

Discussions will continue today, and the growing risks start threatening the oil’s latest advance. A barrel of US crude is still exchanged near the $ 75 this Monday.

If the OPEC+ fails to find an agreement and the crisis deepens at the heart of the cartel, then the oil prices will fall free, and we could see a serious dive which could throw the price of a barrel to $ 50/55 region, as there would be a dramatic, structural change in the supply side of the game.

Also, the Saudi-UAE conflict is more serious than the OPEC/Russia disagreement, given that we are now talking about a friction within the cartel itself. The fall of OPEC is of course not the base case scenario as everyone has a lot to lose in a situation like this – the lone sheep is always in danger of the wolf.

Therefore, the basecase scenario is a delayed OPEC+ deal, and the announcement of 400’000-barrel increase in oil productio, and ideally a plan on what’s to come for the months ahead. In this case, we should see oil consolidate gains and post fresh gains. We shall see a rally to $ 80 mark if Saudi convinces the UAE to follow the extension of lower-supply regime until the end of next year.

Could we see an advance to $ 100 per barrel in case of agreement? Hardly, or hardly sustainable, as higher oil prices are not good for the economic recovery, as a too rapid rise in energy costs would curb the global demand.

Also, if oil prices continue rising at the current speed, inflation which already hit 5% in the US in May, will further threaten the Fed’s ultra-supportive monetary policy and would be a second hit on companies. Therefore, the upside potential in oil remains limited in both cases, yet the latest frictions between Saudi and the UAE increased the risk of seeing a sizable downside correction in global oil prices.