No Envy for OPEC

Risk level: Yellow

RED: Severe (+/- 4%) ORANGE: High (+/- 3%) YELLOW: Elevated (+/- 2%) BLUE: Guarded (+/- 1%)

THE BOOSTER SHOT

-OPEC+ made a mistake.

-A V-shaped recovery is out of the question.

Crude oil prices suffered a deep contraction last week on clear signs that a V-shaped recovery was unlikely. A surprise build in US commercial crude oil inventories and the end of stimulus hopes for the world’s largest economy put pressure on the market. In Europe, an effort by the British government to change part of its exit strategy from the continental economy added to the pressure. Lackluster demand, meanwhile, prompted some of the larger producers in OPEC to cut their official selling price, hoping to encourage bargain hunters to buy up more oil. At issue, however, is where to put it; floating storage is filling up. With OPEC ministers set to discuss the market issues of the day, one has to wonder whether they’d like those extra 2 million barrels per day on the market back in the ground.

A market saturated with OPEC+ oil and hampered by lackluster demand left Brent closing below the psychological level of $40 twice last week. Brent spent much of August hovering around the $45 per barrel mark, though with the summer-holiday season over in the United States, demand will only diminish. The global benchmark finished trading during the week ending Sept. 11 down 6.6% to $39.80 per barrel.

The Organization of Economic Co-operation and Development told us at the start of the month that more was needed to prop up the greater economy. Governments, the OECD said, have taken major steps in pumping fiscal support into their respective economies as the pandemic lingers. Against unprecedented challenges, the OECD applauded governments for making adjustments on the fly to help address the ongoing health and economic crises.

“Uncertainty looms large, however, and continued policy adaptability will be key,” the OECD’s report read. “There is already evidence that the recovery will not be a smooth process, with localized re-introductions of lockdowns in some countries, continued movement restrictions and risks of second and subsequent waves of infections.”

That comes as US lawmakers fall headfirst into the chasm separating the bicameral legislature over a much-needed stimulus bill. According to the US president, the economy is doing fine. Stock markets, led by the tech-heavy Nasdaq, are performing well as much of the business and commercial life in the country moves online. For right-leaning Republicans moving against the recommendations by top health officials to re-open the economy, stimulus to them means returning to work, not more federal support. On Friday, meanwhile, the Federal Reserve Bank of Atlanta revised its forecast for real GDP growth in the third quarter from 29.6% to 30.8%. That said, the US Energy Information Administration reported that commercial crude oil inventories remain 14% higher than the five-year average. Gasoline, though, is doing better at just 3% above the five-year average, though distillates are a whopping 20% higher than the five-year average for this time of year. Given that distillates include diesel and US taxpayers are turning to retail therapy online, the lack of a drain on these products should indicate the economy is not poised for a durable recovery. In May, long before the worst of the US pandemic, the US Congressional Budget Office warned that “improvements will not be large enough to make up for earlier losses.”

The United States is not the global economy, though the transparency makes it a barometer of sorts. India, also one of the world’s leading economy, is dealing with a spike in new cases of the novel coronavirus. We’ll find out later in the week how the stubbornness of the pandemic has impacted demand, as well as what the future may hold, with OPEC and IEA market reports. Don’t forget that viruses like the novel coronavirus spread easier during the winter, and that does not bode well for economic recovery in the northern hemisphere. Peak demand, then, may be already behind us, booming stock market or not.

In July, The GERM Report noted there were modest hopes that the pandemic was under control. At the time though, even US President Trump suggested state economies opened up too fast given the accelerated rates of infection in the US south and west. Barclays Commodities Research at the time was warning that if demand doesn’t pick up, oil prices would experience headwinds for some time. 

“We are not there yet in terms of fundamentals for the next leg higher,” the bank’s note read in part.

Looking at that mid-July statements and it looks like OPEC+ got the economy horribly wrong. By August, the group started changing its tune.

By August, the committee started changing its tune. There were indeed some signs of gradual improvement in the broader market, though “the pace of recovery appeared to be slower than anticipated with growing risks of a prolonged wave of COVID-19.

OPEC+ made a mistake. And now it may be difficult to put those extra barrels back in the box. Since the group started trying to balance with market with coordinated restraint in 2017, compliance has been an issue. Legacy cheaters, such as Russia and Iraq, are also among the biggest oil producers in the world. OPEC, don’t forget, already had its work cut out for it by trying to compensate for a price war between Saudi Arabia and Russia. Now, the group is left scrambling to fix the supply-side mess. Rather than continue to shoulder the burden of restraint, Saudi Arabia sought to incentivize bargain hunters by lowering its official selling price for October crude oil loadings. Qatar Petroleum last week said it too was putting its crude oil on sale and Iraq on Sunday joined the crowd. Relying on oil for nearly its entire state budget, Iraq said Friday it would seek an exemption from OPEC+ restraints, and with the lower price for October loadings, it may start to look like a market free-for-all.  Not to be outdone, Libya may be on verge of an interim market return. Military commander Khalifa Haftar, the face of an opposition government seeking to take down the UN-backed administration in Tripoli, suggested oil could flow unimpeded. If that happens, and if Libya also gets an exemption, the extra 2 million bpd on the market now could look small compared to what’s coming.

OPEC+ is something of a case study on the international system. In that system, there are debates over which formula is most stable; a unipolar system with one entity in charge, a bipolar system where the demarcations (and thereby decisions) are binary, or a multipolar system, where, like the US political system, the various poles of power check the others. A unipolar system may be appealing if we follow the advice of Thomas Hobbes, who favored a “common power” to keep things under control. A singular entity in charge, however, is almost certain to have a universal effort to remove the king from the top of the hill. A bipolar system is easy to manage because the options are clear, though the potential for extreme conflict is high. OPEC+ plus is not a bipolar system, and with Saudi Arabia saying it will no longer be the cross-bearer, neither is it a unipolar one. So we must examine the stability of multipolar systems. Multipolar systems work well to constrain rogue behavior. Given the overlapping networks of connectivity, if one entity tries to break rank, it won’t get very far. But if several do, it’s a sign of how the group feels about change. Multipolar systems are also prone to smaller skirmishes over longer periods of time. The neo-realist thinker Kenneth Waltz observed in his seminal “Theory of International Politics” that parties engaged in cooperative behavior must seek a common denominator.

“They risk finding the lowest one,” he wrote, “and easily end up in the worst of all possible worlds.”

We’ll find out this week if parties engaged in cooperative behavior in OPEC+ are indeed in the worst of all possible worlds.

Eventual-Hurricane Sally could put some wind in the sails of crude oil prices early in the week, though it would be an uphill battle to see $45 per barrel again for Brent because of the storm. Sally’s path looks to avoid most of the main refinery and shale centers in PADD 3, though that sector is still recovery from the impacts of Hurricane Laura last month. The IEA and OPEC monthly market reports will be factors this week, so look there for indications on whether the market is balanced. The big fireworks will be from the virtual OPEC+ meeting later this week, where ministers will try to wrestle with discipline, exemptions, supply-side strains and lackluster demand. With Brexit hitting snags, watch Tuesday for British data on unemployment and earnings. A read of consumer sentiment in the continental European economy is out on Tuesday, as is the IEA monthly report. And it looks like industrial production in the United States slowed down last month. With Israel going on lockdown again, and considering the geopolitical shifting in the Middle East, it will be interesting to see if there’s anything to its latest report on GDP on Wednesday. And its Fed Fun Wednesday in the US, and we get a decision on rates from the Bank of Japan too. Inflation readings for the European economy are out Thursday, as is the latest rate decision from the British central bank. Sentiment from the University of Michigan rounds out the data-heavy week. With Gulf storms, OPEC meetings, rate decisions and the like, it looks like a volatile week ahead, but gains could cap the losses. A Yellow alert is in place, with Brent moving by around +/- 2% on the week.


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