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OPEC Finally Speaks: Does it Change the Trajectory?

Author: Brynne Kelly 7/18/2021

The 19th OPEC and non-OPEC Ministerial Meeting (ONOMM) held via videoconference, concluded on Sunday 18 July 2021. The Meeting noted the "ongoing strengthening of market fundamentals, with oil demand showing clear signs of improvement and OECD stocks falling, as the economic recovery continued in most parts of the world with the help of accelerating vaccination programmes".

Along with extending the existing agreement through the end of December 2022, the group provided clarity around two specific details that have been filtering through the market recently. Specifically, they will:

  • Increase overall production by 0.4 mb/d on a monthly basis starting August 2021 until phasing out the 5.8 mb/d (million barrels per day) production adjustment, and in December 2021 assess market developments and Participating Countries’ performance, and

  • Adjust the Reference Production baseline for certain members , effective 1st of May 2022 .

Additionally, they affirmed that they will continue to adhere to monthly meetings for the entire duration of the Declaration of Cooperation, to assess market conditions and decide on production level adjustments for the following month, endeavoring to end production adjustments by the end of September 2022, subject to market conditions . The 20th OPEC and non-OPEC Ministerial Meeting will be held on 1 September 2021. Below we have the updated figures provided by OPEC as well as providing some logical additional calculations.

Combining the 1.632 mb/d increase in reference production with the existing 5.80 mb/d currently held off line, the group now has agreed upon the ability to raise production by a total of 7.432 mb/d by the end of 2022 (although as noted above, they are 'endeavoring to end production adjustments by the end of September 2022, subject to market conditions').

The two somewhat bearish surprises in today's announcement are related to the following: WHEN the increases are set to begin and the SIZE of the increase in reference production levels by Saudi Arabia and Russia (which equal a combined 1.0 mb/d). Starting the 0.4 mb/d production increases in August might have caught the market a little off-guard as many had expected their indecision up until now to result in August production levels remaining unchanged. At a rate of 0.4 mb/d for the 5 months that remain in 2021, a total of 2.0 mb/d would be back to the market by the end of the year. That leaves a total balance of 5.432 of production that can still come online in 2022 under the existing agreement (including the May 2022 reference production increases). If they 'endeavor' to end production cuts by September of 2022, that leaves 9 months to do so. That's another 0.6 mb/d increase averaged over Jan-Sep 2022. The increase in reference production by Saudi Arabia and Russia was also a bit unexpected as it was the UAE that was the most vocal about wanting upward revisions to their reference levels (which they got along with Iraq and Kuwait).

This isn't the only supply 'growth' on the horizon. For example, Canada’s crude oil export capacity to the United States is expected to grow by over 1 mb/d through the end of 2022. Enbridge’s Line 3 replacement (370,000 b/d) is scheduled to come online at the end of 2021, the TransMountain expansion project (590,000 b/d) is expected to be online in 2022, and additional Enbridge expansion and optimizations to its existing pipeline system can bring more than 400,000 b/d of increased export capacity by the end of 2022.

Given the puzzle above, weekly inventory data has the potential to create quite a bit of volatility going forward as outliers will be closely scrutinized to determine whether or not they signal a worrisome trend. There are a just a lot of moving parts when trying to bring a throttled system back online without blowing a gasket.

But, should we be so worried about the potential risk of building excessive inventories in the petroleum complex? It's a recognized fear given the fact that one of the overarching themes of the pandemic during 2020 was inventory extremes. Yet, fear changes behavior, sometimes forever, sometimes just until the next crisis. The fear of what happened 'happening again' is clouding the interpretation of real data.

Pandemic Lessons

The New York Times reported recently that "Global shortages of many goods reflect the disruption of the pandemic combined with decades of companies limiting their inventories".

This was evident as we saw shortages of things like food items, electronics and lumber. It's likely businesses in this space may have learned some big lessons this past year that are likely to impact behavior going forward. Those industries that experienced shortages are rushing to shore up inventories and supply chains, perhaps even deciding that for the foreseeable future they might need MORE working inventory in order to be prepared for the next emergency (and also benefit from the hoarding behavior of humans during a crisis).

On the other end of the spectrum, we have the the petroleum complex that almost immediately had to deal with a supply glut due to lack of demand last year. Refiners and producers had to immediately cut throughput and have subsequently spent the last year in the difficult position of gradually returning supply to the market as demand returns. As a whole, they may be realizing that they need LESS working inventory, prioritizing the preservation of excess storage capacity should we ever experience another big loss of demand.

It's actually impressive the way the US refiners and producers have managed the system since the initial shock hit early last year. Refiners immediately lowered throughput and worked to move product offshore. The same happened with oil producers and merchants. To say that overall they haven't done a great job, operationally, in the months since would do them all a disservice. Will they be more 'fearful' going forward to accumulate inventories and err on the side of a deficit? Time will tell, but recent evidence suggests that the market wants to get barrels OUT of the system (hence the persistent backwardation).

Perhaps the pandemic has diffused the value of limited working inventory for most consumer goods. However, in the world of crude oil, there seems to be a fear that builds with each weekly inventory release and with each OPEC headline. Did producers and refiners learn a lesson from 2020, or was there even a lesson to learn? Are we on the verge of suddenly being oversupplied as supply wants to keep ahead of demand?

Per the most recent EIA inventory report, combined crude oil, gasoline and distillate inventories are currently below those seen in 2015, the year that production was ramping up in anticipation of the US lifting it's export ban on crude oil.

As a reminder, in December 2015, Congress effectively repealed the US export ban, allowing the free export of U.S. crude oil worldwide. Proponents of the ban argued at the time that its repeal could lead to higher domestic gasoline prices and negatively affect jobs at U.S. refineries. Ironically, a hindsight look at continuous RB gasoline futures doesn't really support that claim.

"Real Data"

We have noted in previous reports that crude calendar spread futures have been unable to realize their bullish intent into expiration. Regardless, the backward structure is having it's desired effect by pulling barrels out of storage. Year-to-date, the US complex had withdrawn more in total from storage than in at least the past 6 years (dark blue bar below).

Outright WTI prices have held the $70-level as a result. But oil prices are nothing without their refined product partners in crime. How have refined product margins fared? Toward that end, this week we take a look at refining cracks via the lens of curve shifts in WTI crack spread futures.

A little over 2 years ago, crack spread futures for 2022 were the 'way back' of the curve (orange line below). A bit of time and a pandemic sent refining cracks into a tailspin lower (red line below). Yet, as of last Friday's Nymex close, calendar 2022 gasoline cracks vs WTI are slightly higher overall than they were before the pandemic took it's toll on flat price (yellow line below). They are on a path to 'realize' at pre-pandemic levels.

The same can not be said for ULSD (HO) cracks vs WTI. Back in 2019 the market was placing a high value on the 'back of the curve' for distillate cracks (orange line below). As last Friday's close, 2022 US distillate cracks have not delivered on the sentiment felt back in 2019 (yellow line below). This is where perhaps the pandemic has left a lasting mark.

Gasoline futures margins have recovered 2019 levels, WTI prices have recovered 2019 levels (below), but distillate margins have not.

But, there is some hope that can be seen via ULSD calendar spreads. During the summer months, when distillate inventories should be building in anticipation of winter usage, calendar spreads should be in contango to reflect such seasonality. Instead, they have been sort of a mixed bag.

The final holdout, playing the role of fundamental guru, is the Aug/Sep spread in ULSD, maintaining some level of composure as the market tries to motivate storage builds ahead of winter via contango. So far, oil spreads are nonplussed by this.

Which brings us back to the question of whether or not the OPEC news changes the trajectory of what really matters: margins. After all, spreads will be spreads regardless of OPEC news, and will keep the market honest. Meanwhile, distillates are raising their hand for attention.


EIA Inventory Statistics Recap

Weekly Changes

The EIA reported a total petroleum inventory DRAW of 3.30 million barrels for the week ending July 9, 2021 (vs a draw of 12.50 million barrels last week).

YTD Changes

Year-to-date cumulative changes in inventory for 2021 are DOWN by 85.30 million barrels (vs down 82.0 million last week)!

Inventory Levels

Commercial Inventory levels of Crude Oil (ex-SPR) compared to prior years are have gone from way above historical levels to slightly below historical levels and should continue to draw as long as backwardation in the market persists.


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