Blink, and you would have missed it
In one of the shortest OPEC+ ministerial meetings in recent memory, the cartel and its allies announced that they would be sticking to their initial plans to keep raising output by 400k barrels a day through November. Some market watchers had suggested that a boost of as much as 800k barrels could have been announced. Oil prices unsurprisingly jumped due to the decision, with Brent rising as much as 3.4% on the day while the WTI front-month contract surged to its highest in seven years. The rally clearly suggests that the market was positioned for a more significant increase in output, given how tight the market currently is amid surging natural gas prices and lower output from the likes of the US.
Lack of supply boost signals tighter market ahead
Oil demand is set to continue to benefit from gas-to-oil switching as the northern hemisphere approaches its winter months, given how frothy natural gas prices currently are. According to Saudi Aramco CEO Nassir, the spike in gas prices has the potential to increase demand for crude by around 500k barrels a day, more than offsetting the increase announced by OPEC yesterday. At the same time, US oil production is floundering following the damage done by Hurricane Ida. Total output from the Gulf of Mexico is down by more than 35mn barrels, equal to almost two full months of OPEC’s current daily supply increases. Expectations are that this will only be fully recovered sometime in early 2022, pointing to a prolonged period of inventory drawdowns which will keep prices propped up. Oil inventories could reach their lowest in 10 years as a result, potentially pushing prices back towards the $90 per barrel mark. The chart below highlights just how far off from pre-pandemic levels total output of oil currently is.
The market will be looking to any comments from OPEC officials for guidance going forward, but so far it seems that the lack of political pressure and complexities of reaching an agreement with all 20+ members of the alliance suggest that it may remain steady-as-she-goes for the next few months.
Frothy prices threaten the global recovery
With oil prices at their multi-year highs and with room to rally further, alarm bells will be ringing at global central banks. The promise of transitory inflation is under threat as high energy costs look set to be with us for longer than previously expected. Given the recent shift towards a tightening bias for most global central banks, a tighter oil market will further embolden the hawkish policymakers among them. Rates could be raised at a faster pace than initially expected, crimping the growth outlook, which could lead to a period of global stagflation.
Bottom-line: Unless OPEC+ makes a notable change to its policies next month, we should see oil prices remain supported through the final quarter of the year. The Northern Hemisphere winter months will drive demand, especially as crude oil will be switched for natural gas given the shortages in that market. This bullish outlook is corroborated by spreads across the futures curve, with Brent’s prompt timespread widening in backwardation compared to last week’s levels, while the spread for the December 2021 contract compared to that of December 2022 remains near its widest level in years. The global macro effect of this is that the period of loose monetary policy may come to an end sooner than currently expected. Not only will this have a notable impact on global economic growth, but asset markets will need to correct and adjust to higher rates, generating greater levels of volatility.