Markets Have Overreacted to OPEC’s Plan To Phase Out Production Cuts

OPEC+ agreed on Sunday to extend most of its oil output cuts well into 2025 amid tepid demand growth, rising U.S. production and high interest rates. OPEC+ is currently cutting output by a total of 5.86 million barrels per day (bpd), or about 5.7% of global demand, including 3.66 million bpd of cuts previously set to expire at the end of 2024, and voluntary cuts by eight members of 2.2 million bpd, expiring at the end of June 2024. The announcement led to an oil price selloff, with front-month Brent falling to a four-month low below $77 per barrel (bbl), good for a hefty $8/bbl decline from last week's high and over $15/bbl lower from April's YTD high.

Commodity analysts at Standard Chartered have pointed out that the price undershooting was the consequence of markets being dominated by a combination of extreme macroeconomic pessimism; speculative shorts and over-enthusiastic algorithmic trading that crowded out more fundamentally-based traders. According to data from Bridgeton Research Group via Bloomberg, oil futures markets have now flipped to a net short position in Brent, compared with a net long position at the end of last week. Related: Oil Under Pressure As EIA Confirms Rising Crude, Fuel Inventories

StanChart says the oil price rout has been triggered by market expectations for a significant volume of OPEC+ oil returning to the global markets 2024; however, the analysts have argued that this explanation does not hold much water. According to StanChart, assuming market conditions are such that the increases can commence, the increase in Q4 relative to Q2 is likely to clock in at a relatively modest 360 kb/d, with the analysts saying that OPEC+ has room to increase production by 1 million b/d without upsetting market balance. Further, StanChart points out that the phase-out will be conditional depending on the state of global markets at the time with most general asset markets not expecting FOMC to follow all its current forward guidance to the letter regardless of future data and events. However, the reaction by oil markets seems to suggest that the forward guidance given by the eight OPEC+ countries concerned constitutes a determination to produce, regardless of whatever happens.

StanChart has pointed out a number of other bullish factors that the markets have overlooked:

•  The 1.65mb/d of voluntary cuts agreed in April 2023 have been extended to the end of 2025.
• The required production level for all OPEC+ countries across 2025 was reaffirmed. 
• The agreement was finally reached in the long-running discussion with the UAE, resulting in a 300kb/d increase in the UAE's required production level, spread out over nine months starting in January 2025.
• Russia, Iraq and Kazakhstan have agreed to produce a compensation schedule for H1 overproduction by the end of June
• The discussion of targets in light of third-party consultant assessments of capacity was postponed until late-2025 when it may be a basis for discussion of 2026 required production.
• The Joint Ministerial Monitoring Committee (JMMC) was given authority to request an OPEC+ ministerial meeting at any time or hold additional meetings should it choose to.

Overall, the analysts say that OPEC+ decisions will ultimately prove positive for oil prices. More importantly, the OPEC+ report has increased transparency with the likelihood of bearish tail-risk events materializing minimized. 

Meanwhile, StanChart has reported that there has been no change in the dominant dynamics of the European gas market, with inventories building slower than usual and the markets still proving highly sensitive to supply issues. According to Gas Infrastructure Europe (GIE) data, EU gas inventories stood at 81.75 billion cubic meters (bcm) on 2 June, good for a 1.1 bcm Y/Y increase and 14.9 bcm above the five-year average. Inventory build over the past week was 1.9 bcm, considerably lower than the five-year average for the same period of 2.8 bcm and last year's 2.4 bcm. The experts also note that the surplus above the five-year average has fallen on 45 of the past 48 days. 

The natural gas supply-side continues to be plagued with challenges. The latest supply disruption that triggered a rally was a fault in Norway's Sleipner gas field. StanChart has predicted that whereas the outage is likely to be short-lived (current estimates are that repairs should be over by the coming weekend), prices are likely to remain elevated bolstered by slower-than-average inventory builds. Dutch Title Transfer Facility (TTF) gas for January 2025 delivery reached a high of EUR 43.30 per megawatt hour (MWh) on 3 June while the front-month contract reached a five-month high of EUR 38.70/MWh on the same day before falling back to settle at EUR 36.014/MWh.

By Alex Kimani for Oilprice.com

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