OPEC+: Chewing the Covid Cud

Summary: while all around are rattled by the emergence of the Omicron variant, OPEC+ was absolutely right to stick to its established plan last week.

We thank 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.

It was just nine trading days ago on 23 November that Brent crude closed at US$82.31pb. Furthermore, sentiment in markets was, if anything, skewed to the upside, i.e. towards an end-of-year price closer to US$90pb consistent with the then most recent forecast from Goldman Sachs. Yet when markets closed at the end of last week it sat at just US$69.88pb. And in between we saw something of a roller coaster, including a flurry of intra-day fluctuations.

All of which begs the question why, when markets are so mercurial, is OPEC+ so seemingly calm?

I must admit to be more than mildly amused by Rebecca Babin’s quote in a 2 December Reuter’s article, as follows: “The markets have just been trying to digest so much news. It’s like a python eating a pony.”

It’s a neat analogy but one which, in my opinion, gives traders more credit than they deserve. The reality is that markets are getting heartburn as soon as they see Ms Babin’s ‘pony’, i.e. reacting to headlines rather than even trying to digest and then decide.

To be fair, there is a degree of inevitability in this given how markets work. But there is far less excuse for the initial mistake which markets made: electing to ignore for months the non-negligible possibility of a new and more dangerous covid-19 variant emerging.

It is much to OPEC+’s credit that it did not lose sight of this, came up with a plan to accommodate the possibility to an extent at least, by increasing output by 400,000 barrels/month, and has, to date, stuck to that plan.

So, let’s backtrack a little and consider why OPEC+ was right to agree to continue to stick to its plan last week.

The new get-out clause is, of course, the key. In contrast to financial markets — and a large number of governments in Europe in particular — OPEC+ has chosen not to ‘knee-jerk’ in response to South Africa’s 24 November announcement that it had found the Covid mutation since labelled Omicron. Rather, as the post-meeting press release states, OPEC+ members: “Agree[d] that the meeting shall remain in session pending further developments of the pandemic and continue to monitor the market closely and make immediate adjustments if required.”

Of course, it is not known as yet just how dangerous Omicron is and also almost as unclear quite when we’ll have a sufficient understanding of it to make decisions based on the science. So, I doubt that the latter was the only factor in persuading OPEC+ to stay the course last week.

At least as important, I’d suggest, was the internal difficulty involved in changing course. A move to cut output would certainly have risked reopening the dispute between Saudi Arabia and the UAE which threatened to split the organisation earlier this year. The moment will almost certainly come when this is unavoidable; but there was little, if anything, to be gained by trying to deal with it now.

A third factor is lobbying by the United States. As I posted on the Arab Digest Facebook page, I am surprised by the emphasis which the Financial Times has placed on this in determining the 2 December decision. With all due respect to the writers and to experts quoted in the article, I suspect they have been seduced by White House ‘spin’ as President Joe Biden seeks to boost his flagging approval ratings by being seen to be addressing what is, after all, a highly sensitive domestic issue in the US, i.e. the price of gasoline at the pump. Nevertheless, I do accept that the Saudis, keen to see an improvement in relations with the Biden Administration, are quietly pleased to get a result from the 2 December meeting which makes it look as if they have responded to some energetic US lobbying over the past few weeks, even to the point of allowing Washington to take an undue amount of credit in public.

This is, in fact, very timely. Both Houses of Congress are considering bipartisan legislation to block the sale of US missile systems to Saudi Arabia, a sale which is supported by the Biden Administration despite pre-election pledges which seemed to indicate that, in contrast to the Trump era, such deals would no longer be countenanced.

Still in Washington, I was tempted to ignore Mr. Biden’s 23 November announcement (coupled with similar statements from other major economies) to release oil from the strategic reserve, if only because the amount to be trickled into markets over five months is only about half the total amount of oil consumed daily by the world. But I have to mention it in the interests of completeness if only to note that (a) markets were certainly disappointed (to the point where it appears not to have been a factor at all in the 24 November sell-off); and (b) OPEC+ also appears to have dismissed it as a drop in the ocean.

Finally, the Federal Reserve. Price fluctuations at the end of last week seem to have been driven initially by two factors: the CEO of Moderna’s suggestion that current vaccines may not be effective against Omicron and the Fed Chairman Jay Powell’s indication that US monetary policy is set to tighten quicker than investors were anticipating. The former we can put to one side until we know more about Omicron. As for the latter, Mr. Powell’s move is consistent with published views of many senior economists that, to quote UBS Global Wealth Management’s Paul Donovan, Omicron is “unlikely to change the broader economic narrative at this stage”. Furthermore, let’s not forget that Mr. Biden may yet get his second stimulus bill through Congress which would be a boost to the US economy at least.

All in all, I can only conclude the OPEC+’s digestive system is in much finer fettle than financial markets!