OPEC+ has been holding back 2.2 million barrels of oil per day for over a year. However, it may now need to consider these cuts as a long-term strategy. The market simply isn’t responding as OPEC+ expected.
Historically, OPEC’s strategy has been simple: reduce supply, let demand absorb any excess, watch prices rise, and then release the withheld oil. This formula has worked in the past, but it is not yielding results this time.
Two main factors are behind this shift: algorithmic trading and overly optimistic expectations about Chinese oil demand. The latter has created a negative market sentiment, and algorithmic trading has amplified this pessimism. While some analysts warn that oil is undervalued and a market correction is overdue, they remain in the minority.
This context led OPEC+ to delay its upcoming virtual meeting, initially scheduled for Sunday, until next Friday. While the official reason was a scheduling conflict, the delay might allow OPEC+ to rethink its long-term strategy. Current market conditions suggest that factors supporting higher oil prices are scarce.
One positive factor is the demand for oil, which continues to surprise on the upside. Non-OPEC oil production, aside from growth in Guyana, isn’t meeting expectations. U.S. shale oil production is slowing, even under the Trump administration. Yet, traders are largely ignoring these fundamentals, focusing instead on China and its unpredictable oil demand.
Another potential boost for OPEC+ is geopolitics. A return of a Trump presidency could mean stricter sanctions on Iran, leading to reduced Iranian oil exports and tightening global supply. Despite this, traders remain indifferent to these geopolitical risks, even as analysts warn of potential supply disruptions.
“We believe oil prices are about $5 per barrel undervalued relative to fair value based on inventory levels,” said Dan Struyven, co-head of global commodities at Goldman Sachs, in a recent Reuters interview. Similarly, Morgan Stanley’s Martijn Rats noted that the oil surplus narrative might be premature and may never materialize, as producers usually adjust by cutting production when faced with a potential surplus.
Despite these factors, oil prices remain subdued. When they do rise, it is often due to temporary disruptions, such as production outages or geopolitical tensions in the Middle East or Ukraine. However, these price increases are typically short-lived, as news about Chinese demand or the International Energy Agency’s latest forecast quickly dampens any momentum.
Given these challenges, OPEC+ may need to accept that its production cuts could become a more permanent fixture. Rather than revising policies every month, OPEC+ could extend the time between adjustments, as it did at the beginning of the current round of cuts. Additionally, it may want to avoid signaling any plans to reverse the cuts, which could fuel further negative sentiment.
This year, there have been several instances of oil price drops fueled by trader expectations that OPEC+ would ease its cuts. Many traders overlooked the fact that OPEC+ had only hinted at unwinding the cuts if the price was right. What’s more, the International Energy Agency (IEA) has consistently missed the mark with its demand and supply forecasts, which continue to influence market decisions.
“I think there’s no room for them to increase, and the market will remind them of that when necessary,” said Torbjörn Törnqvist, CEO of Gunvor, in an interview with Bloomberg. He is correct, not because there is an actual oversupply, but because the market perceives an oversupply. This perception is driving oil prices, and it may take a long time to change this mindset—or perhaps it may never change.
The oil market is “trying to price in a future supply glut that has yet to arrive,” said Jeff Currie, energy strategist for Carlyle Group, formerly with Goldman Sachs. He added that the anticipation of a glut could lead producers to adjust their behavior to avoid it. However, this warning is likely to go unheeded, which could benefit OPEC+ in the long run. When a supply shock inevitably occurs, the market could be caught off guard, sending prices soaring as the IEA’s predictions once again prove wrong.
Until then, OPEC+ may need to treat the production cuts as a more permanent policy.
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