The decision by OPEC+ to stick to its plans for only a small increase in crude oil output in April shows the producer group is increasingly disconnected from the new reality of the market following Russia’s invasion of Ukraine.
The group that houses the Organization of the Petroleum Exporting Countries (OPEC) and allies – including Russia itself – agreed on Wednesday to maintain a long-planned 400,000 barrels per day (bpd) production increase next month. read more.
The group made no mention of the Ukraine crisis in a statement after the meeting, only referring to unspecified “geopolitical developments”.
But more telling was the statement that the “current oil market fundamentals and the consensus on its outlook pointed to a well-balanced market, and that current volatility is not caused by changes in market fundamentals.”
OPEC+ is both right and wrong in this assessment.
It’s correct insofar that the current physical demand and supply fundamentals don’t justify the surging price of crude. Global benchmark Brent futures hit an intraday peak of $115.11 a barrel on Wednesday, the highest since June 2014.
But it’s wrong to say that the outlook for the market is for it to remain well-balanced. And the Ukraine crisis is about to  a major shift in the underlying supply and demand fundamentals.
Russia exports between 4 and 5 million bpd of crude and between 2 and 3 million bpd of refined products. These flows are very much at risk of interruption, even though Western sanctions against Moscow have so far avoided targeting energy commodities directly.
Companies are effectively self-sanctioning, with traders, refiners, shippers, bankers and insurers deeming it too risky to buy Russian crude and products..
It’s unlikely Russian exports will drop to zero in coming months, but the likelihood of them declining substantially is rising with each passing day. The escalation of the conflict in Ukraine and accompanying images of the horrors of war will make it even more toxic to deal with Russia, which calls its actions in Ukraine a “special operation”.
The loss of crude and products from Russia, which is already occurring, will outweigh OPEC+’s paltry 400,000 bpd increase in April output – and that’s assuming the group can even deliver a boost of that size.
OPEC+’s record in increasing output by as much as its stated commitments is weak at best. The group has consistently failed to lift production by the 400,000 bpd per month agreement that started in August last year.
Looking at the OPEC part of the wider group shows that output did increase by more than the commitment in February, with a Reuters survey showing OPEC lifted production by 420,000 bpd in the month.
But notwithstanding February’s performance, OPEC is still about 678,000 bpd short of what it should be producing if it had increased output by as much as the OPEC+ agreement called for.
OPEC MISTAKEN?
This under-production and the likely loss of Russian barrels in coming months means the OPEC+ assessment that the market is well-balanced is not just wrong, but severely wrong.
Even if Russian oil does continue to flow, it’s likely that the usual European buyers won’t take any cargoes. New buyers will have to be found, thus disrupting and re-aligning global flows.
Russian crude may be tempting to some countries that are unconcerned by Moscow’s increasingly destructive war in Ukraine. But if reports from physical traders are accurate, it seems that Russian crude is struggling to find any buyers, even as the main Urals grade is offered at record-high discounts of up to $20 a barrel to Brent.
As a group OPEC has some difficult choices coming. Sticking its head in the sand, as it did this week, is probably not going to be an option.
The first is whether the wider OPEC+ group is now effectively dead, given Russia’s rapid exclusion from much of the world economy. If so, OPEC needs to chart a new course, and work out whether the current high prices are worth the cost of potentially alienating most of your current buyers, as well as major political allies.
OPEC’s main movers, Saudi Arabia, the United Arab Emirates and Kuwait, all count the United States as a major ally, both political and military. But they have so far resisted calls to increase output by more than the OPEC+ agreement in order to calm frazzled markets.
If the oil market continues to fret about the loss of Russian supply and OPEC continues to ignore the problem, then the only outcome left is demand destruction and the associated global economic weakness.
It’s almost as if OPEC’s ostrich stance means it has lost sight of what happened in 2008’s global financial crisis.
By Clyde Russell (Reuters)
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