This week’s OPEC+ meeting will chart out exactly how wide the 23-nation group will open the supply spigot from April onwards, and whether OPEC+ stays ahead, behind or precisely on the rebalancing curve in the months to come.
Our supply-demand balances show that the alliance could in theory increase its production month-on-month in April 2021 by as much as 1.3 million barrels per day (bpd) from our expected March 2021 levels, and still keep the global crude market balanced.
The group still has a self-imposed cap of not raising the target production by more than 500,000 bpd on a monthly basis, which does not include the return of the extra 1 million bpd of Saudi Arabian cuts, which would come on top.
The higher impact narrative of the meeting will therefore be guidance from Saudi Arabia on its plan on when and how fast it plans to return its extra cuts to the market.
While no exact science, the Brent futures curve suggests a quite aggressive expectation for crude stock draws in April, May and June, possibly to the tune of 2-3 million bpd.
OPEC+ thus faces a difficult task in "pleasing the market" with an appropriate return of supply volumes, and different options are considered.
We believe the alliance will most likely "hold steady" near the 500,000 bpd limit and that we will see a gradual return of Saudi extra cuts Such as scenario would yield 0.3 million bpd draws in April 2021.
If we have a more bullish outcome, which would see a complete roll-over of March targets and Saudi Arabia fully holding back its extra 1 million bpd in cuts, we estimate stock draws would only accelerate to 1.3 million bpd in April, which may still not be enough to jolt the oil price rally further.
In a bearish scenario where official targets are raised by the 500,000 bpd cap and the Saudi 1 million bpd cuts fully return in April, the crude market would flip back into stock builds of 0.3 million bpd for April which is definitely not priced in.
We believe the outcome will fall somewhere in the middle, leading to some initial market disappointment. However, it will soon fade because the second half of 2021 looks quite constructive for balances.
Given the expected 5-6 million bpd demand increase through year-end, OPEC+ knows it’s the only source capable of meaningfully meeting a demand of that magnitude.
Meanwhile, within the alliance, there is a primary difference of opinion on how ready the oil market is to absorb new volumes.
Saudi Arabia, the group’s de facto leader that has steered the successful supply cut campaign, says the alliance must be “extremely cautious”, while Russia, a reliable advocate for more supply, has said that the oil market is already balanced. Both are correct.
Oil demand recovery, which we do not see picking up meaningful steam until the second half of this year as the virus mutations force third waves of lockdowns and keep most aviation activity muted, is indeed fragile.
At the same time, the oil market, as Russia points out, if we are speaking about strictly crude, is balanced. Rystad Energy forecasts 0.3 million bpd implied stock deficits in both March and April.
The bearish obstacles are found in the products market, which while also seeing implied draws of 0.3 million bpd in March, is forecast to significantly build by 0.8 million bpd in April.
The variation in these outlooks can be explained by that while refinery demand for crude oil is ratcheting up in hopes of sustained economic recovery, the end-user consumer isn’t necessarily using gasoline and jet fuel at the same rate. So while crude pandemic inventory builds are quickly evaporating, products are still sloshing around.
If OPEC+ chooses to raise the official target production by the maximum 500,000 bpd in April, then the production target for the cutters (ie not including Iran, Libya, Venezuela, and Mexico) increases from 34.0 million bpd in March (which includes the 1 million bpd Saudi cut) to 35.5 million bpd in April 2021.
Looking at global balances, while US oil output recovers, we expect seasonal maintenance in Norway and Canada in April and May sending overall non-OPEC+ lower m/m in these two months.
If we apply our crude demand and non-OPEC+ supply forecast to calculate the call on OPEC+, there is actually room for an extra 1.3 million bpd m/m from OPEC+ in April and an additional 1.4 million bpd m/m in May-21 while still keeping the crude market perfectly balanced.
Our base case, however, anticipates a slightly less sharp reactivation from OPEC+ (1.0 in Apr-21 and 0.6 in May-21). The increase in the call on OPEC+ is slightly below the maximum target production trajectory for Apr-21 if we include the full return of the Saudi cut.
For May, however, the "call" grows by 1.4 million bpd, far above the 0.5 million bpd cap in the current policy pack.
However, high prices will give the supply hawks of the group, led by Russia, more justification in calling for more supply sooner.
In a high oil price environment, Russia will also have more sympathetic ears listening to its call for increasing supply, which will jilt the group dynamics away from the cautious approach led by Saudi Arabia which created the bullish environment in the first place.
So it’s a question of whether to go with the hand that has fed you over the past year, or to break in hopes of a more bountiful future.
In looking at the OPEC+ group’s crude oil production capacity, the group has more than 11.5 million bpd of crude production that could theoretically be activated and produced within three months.
However, the “actual” spare capacity, if we do not include sanctioned countries like Iran and Venezuela, is about 9.5 million bpd. If our forecasted 5-6 million bpd demand increase materializes through year-end, OPEC+ is well-positioned to fill this need.
Looking at the US, our view is that the February freeze outages will be short-lived and that soon enough US oil production will return to growth mode.
Much of this will be driven by the return of private operators in the US shale patch, which can aggressively add wells and rigs and realize returns swiftly in step with the oil price limb.
Later this week, we will publish a round-up of US shale companies’ guidance for 2021. So far we see companies cranking back production ambitions in favor of returning to free-cash-flow and generating returns for shareholders.
There are of course some outliers – such as the private operators – which will strive for double-digit production growth. EOG Resources, for example, said it will increase oil production by 12% starting next year, for now, an outlier. But should the price environment be right, we could see upward guidance from the US shale patch.
Last but not least, prices: Amid rising uncertainty ahead of the crucial OPEC+ meeting, we are expectedly observing some sensation of cold feet among traders, with the flat price and term structure rally taking a breather in recent days.
Our view is still that OPEC+ will likely fall short of implied market expectations for crude balances in April and May, as even the bullish scenario of a rollover would only generate roughly half the stock draws priced in for April.
However, even if a slight disappointment emanates, it will probably not last for too long this time, as market balances look quite constructive for the rest of 2Q21 and for 2H21 in our base case.
Although other market forces – such as massive stimulus programs and buying commodities as a hedge against inflation – have pushed oil higher, actual balances still suggest that OPEC+ would need to wait to increase supply in April or risk a small price correction.
