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OPEC+'s actions show a relatively serious risk of stagflation

Brent crude oil hit a new 10-month high near $93, while WTI is nearing $90. Production cuts by the OPEC+ are raising tensions in markets and raising questions about its intentions. OPEC announced that in the Q4 2023 the market may lack up to 3.3M barrels/day, which may cause the largest deficit in the last ten years. And so Saudi Arabia's reason for cutting production, namely "a stable and balanced market", sounds increasingly ridiculous. The American Energy Information Administration (EIA) predicts that there will be a shortage of only 230,000 barrels per day, and thus there may be accusations that OPEC is trying to drive prices artificially higher so that its members have planned large expenditures. The International Energy Agency (IEA) also predicts a slightly less significant, but still worrying, deficit in the fourth quarter. In the future, it can be assumed that oil prices will definitely rise, because it is becoming more and more clear that the main goal of the gradual reduction in the production of the OPEC+ countries in recent months was not, as these countries keep trying to claim, to maintain a stable and balanced market, but simply to increase prices.

Saudi Arabia is mainly responsible for reducing production, which, with the June reduction of one million barrels per day, reduced its production by roughly 2 million barrels per day compared to last September. In order to achieve the same sales as before the start of June production cuts, it needs to screw up the price to around USD 110 per barrel at the current level of exports. So far this year, according to the IEA, the production of the OPEC+ cartel has fallen by 2 million barrels per day, but the overall losses are mitigated by a significant increase in the volume of oil flowing from Iran. Rising prices led non-OPEC+ suppliers to raise output by 1.9 million bpd to a record 50.5 million bpd. The IEA points out that the current tension in the markets is even more noticeable for refined fuel products: "Refining margins reached an eight-month high in August as refineries struggled to meet demand growth, especially for middle distillates (diesel and jet fuel). Refinery margins and profits have reached near-record levels due to unplanned shutdowns, feedstock quality issues, supply chain congestion and low inventory levels. Suboptimal allocation following the introduction of the embargo on Russian oil and oil products and supply cuts by OPEC+ has caused European and Asian refineries in OECD countries to operate well below the levels they were used to a year ago. While OPEC has control over supply, it can't influence it much, and given the inflationary pressures from rising energy prices again, it's likely to be a while before prices stop rising. In addition, their later decline may end up being smaller than expected. All this entails the potential risk of stagflation, in other words low growth and stubbornly high inflation. The current tensions in the markets are due to political decisions, and not due to the fact that the world is running out of oil.

In the coming weeks, we will be interested in several events that may decide the next direction:

  • Refinery maintenance season is approaching and during this period the demand for oil decreases. Refinery margins, and with them the prices of diesel and gasoline, may remain elevated due to lower supply.

  • How producers in non-OPEC+ countries (mainly in the U.S.A.) will react to higher prices.

  • Due to the diplomatic and legal rift between Baghdad and Ankara, the flow of oil from Iraqi Kurdistan to Turkey with a daily volume of approximately 0.4 million barrels/day has been interrupted since April. A resolution of the dispute would help ease tensions in the market.

If fuel prices continue to rise, the risk of another increase in US interest rates before the end of 2023 may also increase. That could strengthen the dollar but weaken the U.S. economic outlook. The market is under tight conditions. Refinery margins in gasoline and especially diesel continue to be high, and there is also increased backwardation, which is reflected along the entire length of the forward price curve. Among other things, even at the very beginning, where the instantaneous spreads of WTI and Brent oil show a backwardation of over 0.70 USD per barrel, while the backwardation was almost zero when the Saudis imposed production cuts. The increase in one-year spreads is also due to the prospects for a slowdown in demand growth in 2024, which is predicted by all three forecasting agencies. An example is Brent crude, where the pros-23 / pros-24 backwardation spread has reached $8.2 per barrel, while in the case of WTI, the equivalent trades as high as $8.7 per barrel.

Brent crude has been bullish since July with a resistance level at $94 and a support level at $85.50 , which may become the bottom of a new higher band that will emerge due to active supply management by OPEC. The RSI value of 75.5 indicates the tightest price conditions since March 2022. This increases the probability of a short-term decline, but if the price remains above 89 USD, the current upward momentum will probably last.


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