Opec+ Shock Revitalizes Oil Bulls Even As Demand Warnings Flash

The unexpected oil output reduction by OPEC+ sent shockwaves across financial markets, pushing crude prices up by the highest in a year. Now that the dust has settled, one issue remains large: Will the price surge last, or will it go away?

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Immediately following the OPEC+ reduction, banks ranging from Goldman Sachs Group Inc. to RBC Capital Markets LLC boosted their oil-price projections. Yet, many traders feel that a deteriorating economic outlook will prevent the group's initiatives from pushing prices higher. Demand indicators are also beginning to raise red flags.

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That may turn out to be the ultimate test of what matters more to the market: tighter supply or a bleak demand forecast. This will almost certainly increase uncertainty about the trajectory of prices, complicating matters for the Federal Reserve and the world's central bankers in their continuous war against inflation.

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"It's a really difficult market to trade right now," Livia Gallarati, senior analyst at Energy Aspects, said. "As a trader, you're torn between what's going on at the macroeconomic level and what's going on at the fundamental level." It's going in two separate paths."

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One thing is certain: Saudi Arabia and its allies now have a firm grasp on market control, with far-reaching repercussions for geopolitics and the global economy.

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Investors have continued to reward US drillers for output restraint, making it unlikely that shale companies would ever pursue the type of disruptive expansion that helped keep energy inflation under control last decade. This places the oil market under the jurisdiction of OPEC+ at a time when some analysts forecast record demand.

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"The unexpected OPEC reduction has already sparked concerns about a comeback in inflation," said Ryan Fitzmaurice, head index trader at commodities brokerage Marex Group Plc. "These rekindled inflation fears should only grow," he said in the coming months.

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Here's a rundown of what traders will be looking for in the oil market.

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Summer Demand 

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So many oil analysts have expressed surprise at the timing of OPEC's decision.

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The output cuts do not go into effect until May, and most of the consequences are expected to be noticed in the second half of the year. That is when oil consumption normally peaks for the season, due in part to the busy summer driving season in the United States. That is also the time at which China's economic openness is set to kick into high gear, supporting demand even higher.

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Normally, OPEC would seek to take advantage of the consumption surge by selling as much as possible into the market. Instead, the cut indicates that the cartel is holding back. This has sparked speculation over whether the move would drive oil prices above $100 per barrel as demand soars, or whether the cartel and its allies are bracing for a summer of sluggish consumption.

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"Although OPEC+ cutbacks appear to be optimistic on the surface, they do raise worries about the demand forecast," Warren Patterson, head of commodities strategy at ING, said. "If OPEC+ were confident in a good demand expectation this year, would they feel the need to cut supply?"

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Global gasoline market movements highlight demand pessimism. As oil prices rose, changes in refined products were less apparent, reducing profits for refiners in Europe and the United States. Prices of diesel, a crucial refinery product, are reflecting further slowdown fears in Asia, with time spreads falling to their lowest since November.

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Increased Stockpiles

While American stocks are decreasing, worldwide inventories remain high.

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According to the US, Energy Information Administration estimates commercial oil stocks in OECD nations were around 8% higher in the first quarter than the previous year. That's a sizable cushion, and it's indicative of the market's recent downturn in consumption.

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"You do need to gnaw through that overhang first before we can see the benefit," Energy Aspects' Gallarati said.

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Russian Flows

Oil bulls have been waiting in vain for Russia's planned output decrease in March to materialize. The Kremlin announced in March that it would reduce output by 500,000 barrels per day in retaliation for import bans and price caps imposed by "unfriendly countries," but there has been no sign of lower Russian output showing up in the one measure that matters to global crude markets — the number of barrels leaving the country.

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In the final week of March, crude shipments from Russian ports reached a record high of 4 million barrels per day. This is 45% greater than the average recorded in the eight weeks before Moscow's soldiers invaded Ukraine, and it has been enhanced by the diversion of around 500,000 barrels per day transported straight to Poland and Germany since January.

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Production Discipline in Shale

It wasn't long ago that oil traders relied on two key entities for supply guidance: the Organization of Petroleum Exporting Countries and the US shale industry.

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At the moment, OPEC and shale were fighting for market share. For the better part of a decade, it was a quarrel that helped keep global oil prices — and energy-driven inflation — in check.

Then the pandemic struck, bringing with it a drop in oil prices that smothered the fracking sector. Even when the market rebounded and cash flow increased over the previous three years, corporations prioritized dividends and share buybacks over new drilling. It's been a successful tactic. Since March 2020, the S&P 500 Energy Sector Index has risen about 200%, surpassing the S&P 500's return of nearly 60%.

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If the demand for peak shale output grows, OPEC will have one less aspect to consider when making supply choices.

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That's a sensitive place for President Joe Biden, who was eager to dismiss the significance of the cartel's and its partners' agreement to reduce output by more than 1 million barrels per day. After an initial output cut last year, Biden promised "consequences" for Saudi Arabia, but the administration has yet to follow through.

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Since the end of last year, there has been talking about $100 oil, but it appears like the can is getting kicked down the road. For starters, some analysts expected that prices would reach that level in the second quarter of 2023. The view has been delayed into the second half of the year, and now even some of the largest bulls aren't anticipating the magic figure to be reached until 2024.

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These expectations are reflected in the oil futures curve. Prices for contracts related to December 2024 and 2025 delivery have risen, even as benchmark front-month futures have begun to fall.

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"The OPEC+ output reduction boosts the potential of $100 per barrel this year, but it is far from guaranteed," said Harry Altham, an analyst at brokerage StoneX. "Demand-side weakness due to growth concerns is certainly playing a more important role."

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