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Supply issues and difficult oil prices

Oil prices have continued to overall significantly rise since November of last year, on the back of restricted supply of oil agreement by OPEC+ (Organization of the Petroleum Exporting Countries, along with some other oil producers, including Russia) countries. That agreement was up till end-April 2021, but was extended. Given inner competition in the oil cartel means that there is still no agreement on oil supply increase going forward in August and beyond. The problem is not with regard to increase in supply as such, except for Bahrain, which wishes to see higher oil prices for meeting domestic macroeconomic difficulties but with ‘who will supply how much?’. And this is what reportedly became a significant stumbling block between Saudi Arabia and the UAE in the recent OPEC+ meeting.

Highlighting this deadlock, a recent Bloomberg article ‘OPEC+ deal fails, leaving oil market tighter as prices surge’ pointed out: ‘OPEC+ abandoned its meeting without a deal, tipping the cartel into crisis and leaving the oil market facing tight supplies and rising prices. Several days of tense talks failed to resolve a bitter dispute between Saudi Arabia and the United Arab Emirates, delegates said, asking not to be named because the information wasn’t public. The group didn’t agree on a date for its next meeting, according to a statement from OPEC Secretary-General Mohammad Barkindo.’

Another recent Bloomberg article ‘OPEC+ crisis deepens as Saudi Arabia refuses to budge’ presented its understanding of the underlying reason for the OPEC+ deadlock as ‘At the center of the dispute is a word key to OPEC+ output agreements: baselines. Each country measures its production cuts or increases against a baseline. The higher that number, the more a country will be allowed to pump. The UAE says its current level, set at about 3.2 million barrels a day in April 2020, is too low, and says it should be 3.8 million when the deal is extended into 2022. Saudi Arabia and Russia have rejected re-calculating the output target for the UAE, fearing that everyone else in OPEC+ would ask for the same treatment…’

Oil prices, which had already risen 50 percent since the start of 2021; and with the failure of the meeting, have reached their highest levels since 2018 for Brent Crude; and for WTI (West Texas Intermediate) since 2014. According to a Financial Times (FT) article titled ‘Oil hits three-year high after OPEC+ abandon meetings’, ‘Brent crude oil, the international benchmark, climbed 1 per cent on the news to $77.09 a barrel, the highest level since 2018. The US benchmark West Texas Intermediate rose to $76.20 a barrel. On Tuesday, Brent climbed further to $77.84 a barrel while West Texas Intermediate hit $76.98 – the highest since 2014.’

The deadlock is so deep that some analysts reportedly expect that the UAE may even leave the oil cartel, as pointed out in another FT article ‘UAE-Saudi brinkmanship threatens OPEC unity as prices soar’: ‘The clash has opened a rift at the heart of Opec that threatens the ability of the cartel — and its partners in the Opec+ alliance – to deliver oil market stability and could yet see the UAE, a member since 1967, leave the group.’ If this fallout does take place, and the UAE starts increasing supply to cash in on the current high oil prices, others in the OPEC will also likely rush in the same direction, leading to falling oil prices.

On the contrary, if the stalemate continues, and supplies remain muted at the current levels, higher demand at the back of vaccine rollout as economies, especially developed countries with much higher inoculation rates, and in the instance that new dangerous variants remain on the lower side – although the current surge in Delta virus has put some breaks on economic rebound globally – a significant upsurge in oil prices could even see it hitting $100 mark a barrel. This price tag was hinted at in a June 15, 2021 published FT article ‘Oil likely to hit $100 a barrel, say top’, which at that time showed concern over lack of supply increase on the back of significant fall in investment to increase supplies. According to the article, ‘The world’s top commodity traders have forecast a return to $100-a-barrel oil, as investment in new supplies slows down before demand has peaked and before green alternatives can take up the slack. Executives from Vitol, Glencore and Trafigura and Goldman Sachs said on Tuesday that $100 crude was a real possibility, with prices already reaching their highest level in two years this week as Brent crude moved above $73 a barrel.’

Then there is also the aspect of high oil prices in the US, with WTI price reaching its highest level since 2014, with likely consequences for stoking inflationary pressures and working as a retarding factor to an otherwise strong economic surge in the wake of reduction in the intensity of the pandemic due to higher levels of inoculation reached. A recent New York Times article ‘Rising oil and gasoline prices add to U.S. economic challenges’ has pointed out in this regard: ‘The rapid run-up comes at a delicate moment for the U.S. economy, which was already experiencing the fastest inflation in years amid resurgent consumer activity and supply-chain bottlenecks. And it could cause a political headache for President Biden as he tries to convince the public that his policies are helping the country regain its footing.’

The article at the same time indicated that the main problem was not in terms of prices due to, for instance, increase in the share of renewable energy in overall energy mix, until unless, according to one analyst quoted in the article, rose to $120 a barrel, but the main thing which could be a worry for policymakers could be: ‘But if rising oil prices lead consumers and businesses to believe that faster inflation will continue, that could be a harder problem for the Fed. Economic research suggests that prices of things that consumers buy often, such as food and gasoline, weigh particularly heavily on their expectations for inflation. With public opinion surveys showing increasing concern about inflation, rising oil prices increase the risk of a more lasting shift in expectations, said David Wilcox, a former Fed economist…’

In case the OPEC+ deadlock continues with regard to enhancing oil supply, keeping upward pressure on oil prices in US, and as demand continues to pick up on the back of economic rebound there – and the given impact of Delta variant there remains short-lived– may lead to increased chances for a US-Iran nuclear deal, in turn, whereby US likely allowing increased opportunity for Iran to inject oil supplies in the market, and in turn, help bring down prices.

Having said that, US still has some cushion as well, given the highly hedged contracts signed last year by big oil groups in the US, as pointed in a recent FT article ‘OPEC “gets a pass to lift oil prices” as hedging losses hobble US shale’. According to it, ‘some of America’s biggest oil groups are racking up tens of billions of dollars in hedging losses despite soaring crude prices, as contracts signed during last year’s crash leave them selling their output at deeply discounted prices. Oil is trading near six-year highs of around $75 a barrel, but almost a third of the US’s 11m barrels a day of production is being sold for just $55 a barrel, according to IHS Markit, a consultancy.’

These hedged oil contracts have allowed producing an overall much muted impact of oil price rise on US economy in the short run and would likely allow the US administration to wait and see, and give more time to OPEC+ to both negotiate a deal, and in also raising oil prices more for the time being. Here, it needs to be mentioned that rise in oil prices are also desired by Bahrain from the oil cartel – which ‘needs crude prices above $88 a barrel to balance its budget this year, according to the International Monetary Fund’ according to a Bloomberg published article ‘Higher oil prices aren’t yet enough for the Gulf’s weakest link’. This may also become a factor in pushing a deal between US and Iran, nothing with confidence can be said about the future of US-Iran nuclear deal.

(The writer holds a PhD in Economics from the University of Barcelona; he previously worked at the International Monetary Fund)

Dr Omer Javed, "Supply issues and difficult oil prices," Business Recorder. 2021-07-09.
Keywords: Economics , Economic growth , Economic zones , Economic activity , Economic conditions , Sales tax , Stat Bank , Fedral Budget , Economic policy , IMF , OPEC , UAE

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