There is a lot to ponder this week: US consumer confidence report today, the same for the euro zone tomorrow together with US 3Q GDP growth estimates followed by Chinese manufacturing survey, euro zone flash inflation reading and US PCE price index on Thursday and finally US manufacturing PMI on Friday to round up this week’s data releases. Inflation, manufacturing, and growth projections would have a profound impact on the sentiment of oil investors but this week they fade in significance as focus has shifted to the postponed OPEC+ meeting, which will take place on Thursday. As discussed below, the stakes are high as apart from next year’s quota and output levels the unity of the organization will be under scrutiny. Accordingly, oil prices danced to the tune of headlines around the upcoming discussions. An initial weakness was followed by a semi-decent rally only to see prices drift off the day’s summits leaving WTI 68 cents/bbl below Friday’s settlement with the first two spreads in solid contango whilst Brent edged 60 cents/bbl lower.

Sticking to the recent narrative OPEC’s Secretary General accused the IEA of vilifying the oil and gas industry after the energy watchdog of major oil consumers warned the fossil fuel sector of a “moment truth” during the ongoing transition period to clean energy, something that has been lasting for a few years now. Voices out of OPEC are getting louder and “sources” yesterday did not rule out deeper “collective reductions”, a reaction to which from the market was uncomfortably lukewarm. More of the same is anticipated today and tomorrow and it is highly advisable to cancel business lunches and gym sessions on Thursday lunchtime since the formal ministerial meeting is scheduled to begin at 13.00 GMT.

Teabag in Hot Water

There will be no getting away from OPEC this week. The organization strives to stabilize the market, yet the unprecedented decision of delaying the ministerial meeting due to internal discord (at least we do not recall such a move from the past) achieved the exact opposite – it has considerably raised anxiety level amongst investors and consequently Thursday’s get-together will unlikely be a damp squib. There are probably three reasons for the rescheduling: Nigeria and Angola being unhappy with their proposed quotas, Saudi Arabia’s discontent with compliance and the truce in the Middle East that will have ostensibly been over by November 30 (it has been extended by two additional days). It is incidentally the day when the COP28 climate conference kicks off in the UAE (something we are planning to preview in Thursday’s note), hence the virtual discussion on quota and production levels.

Producing nations will start the talks with the full knowledge that taking 5.16 mbpd of oil off the market has failed to provide meaningful support. Oil prices are currently below the April 2023 level and well under the highest print of the year, which is $97.69/bbl basis Brent. The fourth quarter of the current year promised to be very tight, at least according to OPEC’s own estimates, something that is not unconditionally backed up by the IEA and the EIA and not supported by the weekly readings of US commercial oil inventories. Looking ahead, the discrepancies remain for the first quarter of 2024. OPEC’s own estimate for the demand for its own oil is markedly more optimistic than that of the IEA or the EIA. It stands at 29.63 mbpd compared to 27.70 mbpd (IEA) and 27.79 mbpd (EIA). Assuming an output level of 28.00 mbpd these diverging views make all the pivotal differences between global stock build and depletion.

Nothing is a more trustworthy barometer of the sentiment than the market itself and currently the outlook is disenchanting. The Saudi energy minister argues that the current weakness is the product of financial players, who ignore the state of the physical oil market, which is nothing but tight. However, money managers have the same access to information as those active in the physical markets and the current interpretation of forecasts and estimates is bearish. It means that additional output constraints would need to be implemented to brighten the present mood. The problem with that is, as outlined above, the dissatisfaction of some members with the allocated production baseline figures in addition to the lax compliance to these quotas.

Producers always want higher quotas from which cuts are calculated. If you are required to constrain 1 mbpd of your output, you will have higher revenues if your quota rises from, say, 5 mbpd to 5.5 mbpd. Persian Gulf producers, notably the UAE, recently argued that their reference level should increase because their spare and thus total capacity increases. Consequently, it managed to secure significant concession as its output will go up by 200,000 bpd in 2024. This, African producers argue, is an unfair advantage, simply because their reliance on scarce outside investment is much higher than that of their Middle East peers, therefore they are not able to increase their production capacity as fast as Persian Gulf producers. Higher production quotas with rising capacity, though are perfectly justified and it is a logical approach but maybe they should also entail proportionally elevated cuts to make the playing field as level as possible and the allocation of quotas a quasi-automatic and transparent process.

Thursday’s discussions, for the reasons mentioned above, will likely be heated. Saudi Arabia and Russia are both widely expected to roll over their voluntary output/export cuts into 2024 with other quotas, apart from the UEA, remaining untouched. Barring any negative surprise, the recent drop in prices will probably be viewed as a buying opportunity, especially if further cuts are agreed. Nonetheless, given the market’s nonchalant approach towards meaningful supply deficit, and the severely diminished appetite for compliance, the upside should be capped. On the downside, whilst a supply war is implausible, it must not be completely discounted; just remember April 2020. Robert Mabro, the founder of the Oxford Institute for Energy Studies, once compared OPEC to a teabag, which works best when in hot water. Well, the water is near boiling point.
 

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