Oil: In Search Of Stability

Summary: despite what was, by all accounts, a challenging discussion at the OPEC+ table last weekend, Saudi Arabia appears to have engineered a pragmatic outcome consistent with its drive to stabilise the oil price.

We thank our regular contributor Alastair Newton for today’s newsletter. Alastair worked as a professional political analyst in the City of London from 2005 to 2015. Before that he spent 20 years as a career diplomat with the British Diplomatic Service. In 2015 he co-founded and is a director of Alavan Business Advisory Ltd.

What a difference two months can make!

Back in April, the ground for a cut in output had clearly been carefully prepared by the Saudis before the very brief virtual meeting was even convened (see the 4 April Newsletter). In contrast, the 3/4 June (physical) meeting of the OPEC+ cartel appears to have been a trying one. Certainly, that a decision did not emerge until late on the second day is confirmatory of strong differences of opinion around the table.

To be fair, the context in which the meeting was taking place was far from straightforward for two reasons: the internal dynamics of OPEC+ and uncertain prospects for the world economy.

On the former, despite the cuts in output announced in April the price of Brent crude had slid back to only a little over US$70 per barrel (pb), suggesting that further trimming was on the cards, as I concluded in the 15 May Newsletter. However, reluctance from smaller producers in particular to go down this track had led the FT’s David Brower to write in his 1 June newsletter that OPEC+ would “sit pat”, adding that:

That’s also the consensus of other analysts who follow the group closely. The cuts announced in April have barely had time to take effect and anyway, most forecasters expect a significant increase in global oil consumption later this year, tightening demand and supply balances.

In retrospect, I think we can reckon that his “other analysts” underestimated Saudi Arabia’s determination to try to stabilise the oil price, probably somewhere between US$80pb and US$90pb, bearing in mind that the lower end of this range is widely believed to be the threshold at which Riyadh balances its budget. Consistent with this is the fact that the Saudis alone have been prepared to implement a further cut from 1 July, bringing their output down to a remarkably low nine million barrels per day (bpd) which is only around 75 percent of their capacity. Furthermore, other agreed cuts which are set to follow at the start of 2024, from small African producers, reflect no more than the output reality rather than a genuine reduction. Similarly if there is, in due course, a reduction of Russia’s quota, which is to be the subject of an independent investigation.

There is, however, one important exception to these downward moves which is not, in my view, receiving the attention it deserves. Last weekend’s meeting agreed to the UAE’s baseline being increased with effect from 1 January 2024 from 3mbpd to 3.2mbpd. Two years ago (see for example the 21 July 2021 Newsletter) there were grounds for believing that OPEC could fall apart thanks to a disagreement between Riyadh and Abu Dhabi over increasing the latter’s baseline, an issue which was never really resolved. It appears that, amid all the wrangling about cuts last weekend, the Emiratis have made some progress on this.

Moving to the global economy, it is telling that the agreed cut in Saudi output of 1mbpd is initially for one month only, albeit with a provision to extend which, presumably, will be kept under constant review relative to economic prospects. To date at least the consensus has been that demand for oil is likely to rise sharply in the second half of the year. However, this is based principally on forecasts for China to have effected a full post-COVID economic recovery by then. Wall Street analysts are still pushing the ‘China boom’ story (Barclays and Nomura, which recently downgraded their forecasts, being notable exceptions). However, writing in the 21 May edition of the FT, Rockefeller International Chair Ruchir Sharma argued that a growth model which for fifteen years now “has been based on government stimulus and rising debt…has run out of steam.” This is not to say that we will not see any pick-up in growth between now and year-end; indeed, it is safe to assume that Beijing will do everything possible not to repeat last year’s shortfall of the official growth target. However, as Mr Sharma and an increasing number of other experts have been arguing for some months now, China has reached the point in its development where potential growth is probably around no more than three percent per annum. Coupled with the ongoing push towards greater energy self-reliance based principally on renewables, we may need a major rethink on China’s short- and long-term demand for oil.

As for the US, both the pieces of good economic news we had towards the end of last week need to be viewed with caution.

First, the crisis over the debt ceiling was finally defused. However, as they did after the 2011 crisis, investors may be overestimating the probability of a relief rally. JP Morgan’s Jay Barry has calculated that, in order to make up for four lost months while the politicians have been arguing over raising the debt ceiling, the US Treasury will need to issue around US$750bn in new bills in the coming four months and around US$1.1tn between now and the end of the year. This will soak up liquidity in a banking system which is already under stress and is also likely to act as a drag on equity markets. Furthermore, cuts in government spending consistent with the terms of the deal may have a negative impact on the overall economy.

Second, last week’s ‘goldilocks’ jobs data is all well and good; but it will likely encourage the Federal Reserve to fret even more about wage inflation, thereby pushing up the probability of further rate hikes.

In summary, one might tentatively conclude that the decisions reached at last weekend’s OPEC+ meeting are not at all unreasonable given the uncertainties over the world’s two largest economies and Riyadh’s commendable quest for oil price stability.