Tensions in the Middle East threatens the disruption of oil – London Business News | Londonlovesbusiness.com

Brent traded slightly above $80 per barrel just a few days ago. In the context of inflation, this may not seem low, but it is far from the peaks of the last two years, when it often cost $90 or even $100 per barrel.

Recently, investors have been sceptical about the strength of demand in the two main engines of the global economy: the US and China.

At the same time, however, the OPEC+ cartel has been maintaining voluntary production cuts, leading to an artificially balanced market or even a slight deficit, which sustains relatively high oil prices.

It turns out, though, that the OPEC+ decision regarding the future of the voluntary cuts agreement is not as important as geopolitics.

It was the latest escalation in the Middle East that led to a significant rebound in oil prices. Will the OPEC+ decision boost prices further?

Tensions in the Middle East

Conflict between Israel and Hamas in Gaza Strip was not front-page news for the past few weeks. On the other hand, the helicopter crash with the Iranian president on board has refocused journalists’ attention on the Middle East region.

The death of the Iranian president and the foreign minister led OPEC+ to postpone a ministerial-level meeting by one day to June 2.

Additionally, this meeting will be held via videoconference rather than in person, as previously planned. However, this is not the end of the increased geopolitical tension in the Middle East. Israel bombed a refugee camp in Rafah, sparking international condemnation and calls for an end to military actions in the Gaza Strip.

Moreover, there have been two attacks on tankers in the Red Sea by Yemeni Houthis, which remind about the threat of disruption of the world’s most crucial raw material supply. These combined events have led to oil rebounding by about 5% from last Friday’s lows, and it is on track for the largest weekly increase since the end of March.

OPEC+ Decision

The expanded OPEC+ cartel is reducing oil production by almost 6 million barrels per day! This is more than 5% of the global oil supply. This figure includes precisely 3.66 million barrels per day of cuts related to the COVID-19 pandemic, which are to be maintained until the end of this year.

Additionally, most OPEC+ countries joined Saudi Arabia and Russia in voluntary cuts in November last year, reducing production by an additional 2.2 million barrels per day. Initially, the voluntary cut was to last until the end of March but was extended to mid-year.

Currently, it is expected that OPEC+ will decide to extend this cut, so the lack of such a decision could be a significant disappointment for the oil market. Compliance of production cuts with imposed limits is also important.

According to calculations by Bloomberg, Reuters, and other data agencies, production among the participating countries is about 200,000 barrels per day higher than it should be. This is not a large number from the perspective of the entire oil market, but it is important considering the global balance.

OECD stockpiles have remained basically stable for many months, indicating that demand may indeed have some issues. Therefore, the best scenario for oil is not only the extension of voluntary cuts until the end of this year but also increased compliance with production limits or even attempts to make up for previous undercompliance.

Demand in China Slows, but US demand rebounds

China accounted for about half of the total oil demand growth last year. Indeed, the country had a daily fuel demand of over 15 million barrels per day last year, which has now decreased by about 0.5-1.0 million barrels per day. Additionally, there is no sign of increased interest in building up stockpiles in China.

Stocks in ports are low, but global stocks on the water have risen to levels significantly higher than the 5-year average, which may suggest a possible rebound in imports to China. Furthermore, market participants do not talk much about India, which is currently a growing market but lags behind China in terms of nominal demand levels.

Will we see significantly higher prices?

It is worth noting that without OPEC cuts, the market would remain in a strong surplus. On the other hand, the total cut of 6 million barrels per day does not mean that OPEC+ countries would be able to increase production by that much.

The production capacities within the OPEC cartel and Russia have significantly decreased in recent years. Nevertheless, producers currently have no incentive to produce more, as this would mean prices as low as $40-60 per barrel.

Prices can react to changing geopolitical situations. In the case of a blockade of the Red Sea or a worse situation, such as a blockade of the Strait of Hormuz, prices could return above $100 per barrel. However, this does not seem to be the base scenario. Prices of $90 per barrel in the first quarter of this year were driven by geopolitical situations rather than the current difference between supply and demand.

Moreover, demand in the coming years may not grow as dynamically as in the last 10-20 years (excluding crises), due to the energy transformation. Electric cars are increasingly popular not only on American and European streets but especially in China, which may result in the demand weakness.