Oil traders have been kept on their toes all day Thursday.
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Markets had a lot of new information to digest, resulting in oil prices being whipped about over the past few hours.
Here’s a quick recap:
- Brent gapped down: The Financial Times issued a report that Saudi Arabia may send more barrels out into the world.
- Brent erases losses: OPEC+ confirmed a larger-than-expected hike to its output for July and August to 648,000 barrels per day. That’s about 50% more than the expected 430,000 output hikes that had been widely expected.
Yet, markets seemed to think that the ramping up of OPEC+ output will not significantly dent the supply deficit in global oil markets.
- Brent climbs higher, then pares gains: The EU approves a 6th round of sanctions. Member states would be banned from importing Russian oil that’s delivered by sea (as opposed to pipelines over land) in six months.
- Brent restores gains: According to the EIA, US inventories of crude oil posted a drawdown of 5 million barrels, which is much larger than the market-estimated 2.1 million barrel drop.
This is seen as evidence that supply isn’t keeping up with demand, especially as the US driving season (think of summer road trips) gets underway.
Such rapid-fire developments resulted in heightened volatility in oil prices on a day that was initially expected to see another ho-hum session.
Before we take a closer look at some of the developments stated above, let’s first revisit some basics.
What drives oil prices?
Fundamentally, oil prices react to supply and demand.
- When there isn’t enough supply to meet demand, prices tend to rise.
(for example, consider how sneakerheads bid up prices to get their hands on limited-edition Jordans or Yeezys).
- When there is more supply than demand, prices tend to fall.
(e.g. discounts that are offered by grocery stores for goods that are idling on their shelves)
Furthermore, note that markets are forward-looking in nature.
In other words, investors and traders move prices based on information or beliefs they have at present about what the future may hold. Current prices reflect tomorrow’s outlook.
What is OPEC+?
OPEC+ is an alliance of 23 major oil-producing nations, with Saudi Arabia and Russia seen as its de facto leaders.
Their collective job is to determine how much of their oil supplies are sent out into the world, which in turn influences oil prices.
And that now brings us to today’s big two, oil-related announcements: the surprise OPEC+ decision + the latest EU sanctions aimed at Russian oil imports.
1) Larger OPEC+ hike? Markets go ‘meh’
For context, OPEC+ has had an agreement in place since July 2021, whereby members ‘gradually’ restore the output that had been shuttered since the pandemic.
And by ‘gradually’, they meant raising output by 400,000 – 432,000 bpd per month.
Hence, today’s announcement of an extra 50% for July and August 2022 may seem like a big jump, at least on paper. Furthermore, today’s move appears to be a dramatic shift away from the alliance’s ‘gradual’ stance.
However, what OPEC+ says vs. what OPCE+ does are two very different things.
Markets have had their doubts for a while about whether OPEC+ can actually deliver what it says it will do, considering that OPEC+ had collectively under-delivered in recent months.
The likes of Angola, Nigeria, and Libya have struggled to meet their respective ramped-up output quotas due to the lack of investment and political unrest. Though to be fair, Nigeria did raise its output in May registered a climb for the first time in four months, up to nearly 1.5 million bpd.
Overall, while OPEC+ points to a substantial increase in output, markets think that what will actually be delivered will not be enough to keep pace with the global economic recovery.
2) EU sanctions provide bigger boost for oil bulls
Markets are also of the opinion that it’s the prospects of more Russian oil being inaccessible to global customers that will be more keenly felt than any additional OPEC+ output.
- As a simple reference, Russia pumped an average of about 10.2 million bpd last month.
- Compare that versus the combined 400,000 bpd in extra output (which were initially slated for September’s output hike) that OPEC+ is bringing forward across the next two months.
Contrasting those two sets of numbers would give an immediate sense that the further choking of Russian oil is set to have a far greater impact on global oil supplies than what OPEC+ has pledged.
Overall, markets are already getting the sense that oil is set to remain scarce in the months ahead.
Countries that are already thirsting for the black commodity could well find it even harder to get their hands on the barrels of oil that they desperately need and want, more so when China further eases up on its virus-curbing measures.
Hence, oil prices are set to remain in a well-supported environment, evidenced by how quickly oil erased its losses today.