OPEC+ delivers “slap to the face” with a minuscule 82-second lifeline; US crude inventories rise unexpectedly

During the much-awaited OPEC+ meeting, member countries led by Saudi Arabia and Russia agreed to increase their collective output target by 100,00 bpd (barrels per day) come September. This is a drop in the proverbial ocean with producers catering to a global market of approximately 10 million bpd.

A Reuters report noted that this increase would satisfy only an additional “86 seconds of global oil demand” per day.

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Although a small or even no increase at all was in line with market expectations, analysts were surprised by the less-than-token improvement in the output ceiling, prompting some to interpret this as a deliberate attempt to humiliate the US.

For instance, Robert Yawger, executive director of energy futures at Mizuho Securities, stated that this “is a slap to the face for President Biden.”

This outcome would have been very disappointing for the President who made a special trip to meet with Saudi authorities last month.

To add salt to injury, the OPEC+ decision comes a day after the US cleared $5.3 billion in missile sales to both the UAE and Saudi Arabia.

Prices slide

Prices were steady after the OPEC+ announcement, with Brent trading slightly above $100.

However, with the publication of Energy Information Administration (EIA) data, prices have crashed by over 3%, with Brent trading at $97.3 and WTI as low as $91.2, at the time of writing.

The EIA reported an unexpectedly large build in US oil inventories which rose by 4.5 million barrels for the week to July 29. Gasoline stocks were also up 200,000 barrels in the week ending July 29^th, potentially reflecting a moderation in consumer demand as the US exits the driving season.

As per market surveys, both these figures were expecting a drawdown, in line with the previous week, but stocks have surprised to the upside raising concerns of demand sustainability.

American conundrum

The US is tussling with four-decade high inflation rates and gasoline prices in excess of $5 across several major cities. The administration is desperate to ease the market tightness and bring down costs.

An argument could be made that any increase at all would be deemed to be symbolic since the OPEC+ countries have long been struggling to meet their quotas in any case.

With the onset of the pandemic in 2020, followed by a sudden drop in aggregate demand, laying-off of skilled labour, disrupted supply chains and chronic underinvestment in these countries, OPEC+ members simply do not have sufficient spare capacity to meaningfully increase global output.

The only two countries that may have the ability to increase production sizably are Saudi Arabia and the UAE. For Saudi Arabia, this would be a challenging task due to many of the same reasons listed above, in addition to which, most untapped reserves are in “untested fields” and would take months to operationalize.

Moreover, Saudi hydrocarbon law requires that any official increase in production targets be met for a minimum of at least 1 year. The Kingdom is unlikely to want to boost supplies significantly for such a lengthy period, as a deep recession is widely expected.  Ramping up production would only lead to cutting off windfall profits that member countries are presently enjoying.

Lastly, the Saudi government would be unwilling to cross its Russian ally by hiking production targets too fast. Given the strict sanctions that the West has imposed on Putin’s Moscow, Russian export channels have dried up and a tight global oil market is supportive of Russian revenues for the time being.

Would OPEC+ expansion do the US much good?

Market estimates reported that combined OPEC+ output is running at nearly 3 million bpd below-assigned quotas.

Despite these challenges, one must question if the US is trying to solve the right problem. Even if a substantial increase in crude oil output were to materialize, refinery capacity in most countries, including the US is very tight.

The overall tightness in the petroleum chain is driven by refined products, due to the lack of refining capacity which can’t easily be rectified.

It is unlikely that any increase in global output would make a tangible difference at the pumps, although a favourable outcome may have boosted the President’s ratings at home.

In the United States, the operating rate of refineries was registered at 91%, down from 92.2% the week earlier. This leaves limited room for the processing of any additional crude.

Any relief is likely to come from slipping demand, as the summer driving season in the US draws to a close.

Ongoing actions

Speaking with Bloomberg, Amos Hochstein, an energy adviser to the Biden administration stated that oil prices would need to fall below $90 to meaningfully improve the situation for U.S. households.

Although a long shot in itself, the Biden administration has also invited top Irani officials back to the negotiating table to discuss the possible easing of sanctions to improve international oil exports from the country.

The rising demand for ESG-compliant investments and alternative fuels is continuing to pressure long-term expansion in energy infrastructure.

The International Monetary Fund in its latest estimates cut global growth forecasts to 3.2% and 2.9% in 2022 and 2023. Given the anticipated slowdown in economic activity, the market is unlikely to see a significant injection of new oil sources and additional volumes, although receding demand may lead to easing prices.