OPEC In Control and Other Dumb Memes

The world got a surprise last weekend from OPEC+. It’s going to cut more than 1 mmb/d of oil output beginning in May.

That announcement was a call to action for analysts to disgorge a slew of shopworn memes rather than provide any useful insight or critical analysis that might help investors.

This is my favorite because it combines two popular memes that have persisted despite being completely untethered to reality.

“One thing is for certain, OPEC is in control and driving price and U.S. shale is no longer viewed as the marginal producer.”

James Mick, Tortoise Capital Advisors

OPEC is not, never has been, and never will be in control of oil markets. Oil is the largest commodity market in the world. It can be manipulated by a big enough player for a short time but it’s simply too big to control. There are approximately 2.8 billion open interest barrels of Brent and WTI in that market whose value is more than $210 billion. That’s 20% of Saudi Arabia’s expected 2023 GDP.

OPEC and its current OPEC+ incarnation is effective at moving price up or down for a few days or weeks. The 2 mmb/d OPEC+ cut in October 2022 raised Brent price about $4.50 for two days before it dropped to a lower price than when the cut was announced. The recent announcement resulted in a price increase of $5.35 but 98% of that was in the first day of trading and price has now leveled off. That’s some powerful manipulation but hardly control.

The second meme in James Mick’s comment is about U.S. shale as the marginal producer. He means that the U.S. used to be the world’s swing producer in the shale boom but is no longer.

How absurd. The U.S. was never the world’s swing producer and probably never will be because a country must have spare capacity and be a net oil exporter. The U.S. has had no spare capacity nor been a net exporter of oil since the early 1970s.

Another dumb meme is that oil markets are “tight” or “incredibly tight” as in this quote from last week:

“The announced cut would further tighten an already fundamentally tight oil market, driving the Brent benchmark towards $100 per barrel sooner than previously expected and would push the price to around $110 per barrel this summer.”

Rystad Energy

Energy Aspects’ Amrita Sen is among my favorite analysts but I count no fewer than 5 interviews over the last 6 months in which she has said that markets are tight or incredibly tight.

If markets are so tight, why has OPEC cut production twice in the last six months? Why have oil prices failed to regain $100/barrel since August 2022?

Figure 1 shows OPEC and EIA supply, demand and supply-demand balance through 2023. Two things are immediately obvious.

First, supply and demand have not recovered to the 35-year trend line since their decreases during the 2020 Covid pandemic. That is a problem that continues to vex OPEC and is essential to understanding its output cuts this month and in October 2022.

Second, the supply-demand deficits for the second half of 2023 do not appear to justify the tight market narrative. Those projected balances, in fact, suggest approximate market balance and much smaller potential deficits than those in 2021.

It’s impossible to know why OPEC decided to cut exports last weekend but I’m confident that fears about the direction of global economy were central.

The following comment is from OPEC’s current Monthly Oil Market Report.

“Any negative impact from current monetary policies, or measures potentially ahead, could impact global debt markets, hence slowing global economic growth. The rapid rises in interest rates and global debt levels could cause significant negative spill-over effects, and may negatively impact the global growth dynamic. Finally, protracted geopolitical tensions in Eastern Europe could further add to the downside.”

The last sentence in that statement is crucial.

We have reached a state with the war in Ukraine that Chuck Watson calls risk homeostasis. We understand but minimize its potential for disruption because it is not front-page news the way it was last year. Also, the energy and materials crisis that rocked the world last year has subsided for now.

The elephant in the room is the very real possibility of a nuclear exchange. I’m not thinking about the kind of mutually assured destruction scenarios of the Cold War but rather, the use of tactical weapons.

This probably doesn’t sound so bad by comparison but I’m willing to bet that few people understand what this means. For those who dare to learn more, please follow this link to Chuck Watson’s discussion with Nate Hagens on this and related subjects.

I suspect that the OPEC+ surprise export cut last weekend was intended to put a floor under oil prices for now. I for one am willing to take OPEC+ at its word that the objective of its action is to stabilize markets.

If we have learned anything over the last several years from Covid and the war in Ukraine it should be that the real global macro for low probability-high impact events seems to be greater than we previously thought possible.