When OPEC and its partners led by Russia first announced additional oil production cuts last year, the market brushed it off. Prices fell. Forecasts for peak oil demand echoed off news publications.
OPEC+ persevered, however. It persevered to the point where some analysts noted that there was no longer a way back, and the cartel would have to make the cuts permanent if it didn't want to see prices plummet at the slightest sign of production growth. And then something happened. The market caught up.
Brent crude closed above $87 per barrel on Friday and still has higher to go if analysts from some of the biggest banks are to be believed. Of course, analysts are often wrong since they are not immune to errors, and indeed, many made an error this time: they believed the oil demand decline predictions coming from organizations with a vested interest in such a development. And they missed the supply tightening risk.
That tightened supply is already a fact. This is what prices are reacting to, as reports about declines in global oil inventories and lower OPEC+ output come in. McKinsey reported in February that global oil inventories had shed 32 million barrels the previous month, with the tightening especially marked in OECD countries.
LSEG, formerly Refinitiv, also reported an inventory tightening in late February, with Reuters citing a JP Morgan report warning that global oil inventories were at the lowest in seven years, per Kpler data. Related: Who Is Behind Iran-Backed Houthi Threats To Attack Saudi Arabia?
"The market has found a firmer footing with Brent trading above $80 for a while now, supported by what looks like a better-than-expected demand outlook together with the...tanker diversions keeping millions of barrels at sea for longer," Saxo Bank's commodities chief Ole Hansen commented at the time.
Indeed, demand was perhaps the greatest underestimation on the part of analysts and traders. It is the expectation of weak demand that kept prices low for months even as OPEC cut production by over 2 million bpd, and even as forecasts about U.S. shale pointed towards much slower growth this year.
Now that fresh demand data is coming in, prices are climbing higher. Since the start of the year, Brent has gained 11%, according to Bloomberg, which recalled that OPEC had no plans to make changes to its output agreement at its next meeting, on Wednesday.
"The OPEC cuts have been effective," Michael Hsueh, a Deutsche Bank strategist, told the publication. "The global market is either already in deficit or on the verge of turning into deficit."
Indeed, Standard Chartered warned of a deficit back in mid-2023. Yet, at the time, nobody listened. And why would they, when U.S. shale oil production was soaring unexpectedly, despite a lower rig count. Now, the warnings are multiplying—including one from the International Energy Agency that just three months ago forecast a comfortable supply situation on global oil markets because of weaker demand that would match the lower OPEC+ supply.
It appears that most forecasters ignored the fact that production curbs amplify the disruptive effects of unforeseen events on market balance. In this case, these effects have come from the Red Sea situation where repeated Houthi attacks on ships have led to a massive reorganization of maritime transport that has added at least 100,000 bpd to global daily oil demand, and, more recently, Ukrainian drone attacks on Russian refineries that have affected fuel supply and raised concern about crude supply.
Had OPEC+ not cut, the effect of these events would have probably been more muted. With the cuts, anything out of the ordinary has the potential to push prices sharply higher. This is why analysts have rushed to revise their forecasts, with Energy Intelligence reporting last week that the dominant expectation is of a deficit. That deficit, according to forecasters, is the result of weaker-than-expected supply and stronger-than-expected demand.
Once again, we see a discrepancy between actual trends in oil fundamentals and expectations of future changes in these trends, based on forecasts with questionable basis—and bias. OPEC+, meanwhile, can sit back and relax while it watches prices creep higher still.
"Every month that OPEC discipline remains in-place, Brent flat price will likely continue to catch up with where inventories and time spreads already are," Morgan Stanley analysts said recently.
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Meanwhile, those counting on continuous growth in U.S. oil supply that could offset OPEC+ cuts got a reality check from the latest numbers, for January, which showed a decline rather than growth in output—due to harsh winter weather. While not unheard of and certainly not a sign of a long-term trend, the January output change in the U.S. provided a much-needed reminder that sweeping assumptions can be risky.
The assumption that U.S. production will continue growing at the same—or faster—pace as it did last year and offset the OPEC+ cuts was among the riskier. The assumption that oil demand is in decline because some people somewhere who stand to benefit from such a decline predicted it would decline proved to be an even riskier one. And now everyone is catching up with the actual physical market, which was bound to happen sooner or later.
By Irina Slav for Oilprice.com
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The Saudi cut is a cut that never was since Saudi Arabia couldn't produce it anyway because of production difficulties. Moreover, out of the remaining 1.2 mbd made by other OPEC+ members, it is estimated that only 600,000 barrels a day (b/d) were implemented at best. Such a small volume will hardly impact the market and prices.
What is currently pushing oil prices higher is solid fundamentals, robust oil demand, a tightening market and roaring Chinese crude imports. That is why Brent crude will very soon break through $90 a barrel. And if geopolitical tension in the Middle East escalates, Brent could even go beyond $100.
Dr Mamdouh G Salameh
International Oil Economist
Global Eneergy Expert