Many observers fear that due to the failure to reach an agreement, oil supply will be insufficient to meet rising demand and that prices could surge. According to International Energy Agency (IEA) projections published in mid-June, global oil demand will rise by 4.4 mbd between the second and fourth quarters of 2021. The IEA also estimates that oil supply from non-OPEC+ countries, of which the largest producer is the US, is expected to increase by about 1.3 mbd. The amount of OPEC+ supply needed to balance the oil market would still be about 0.65 mbd higher than what OPEC+ countries would have produced based on the agreement proposed at the July meeting last meeting. The "planned" supply deficit by OPEC+ would have sparked a further moderate decline in petroleum products stocks from levels that remain high, especially when measured in terms of days of oil consumption, and consolidated prices around current levels. The risk is that the supply deficit is now much larger, and that upward pressure on prices increases.
This is a problem for OPEC+ for several reasons. First, high oil prices in a situation of rising demand will encourage US shale oil producers to increase production and gain market share. US oil production is about 2 mbd below pre-Covid levels and could be significantly increased in a short period of time.
Secondly, if oil prices rise much further, they will eventually reduce demand for oil products. Not only will consumers look to save on their energy bills, but global growth will slow down, reducing oil demand from the producing sectors as well. The pressure on oil prices could then turn downwards again.
Finally, high oil prices will accelerate the energy transition to renewable sources. The transition is needed to achieve UN targets for limiting greenhouse gas emissions and global warming. If prices for renewable energy become even cheaper than for fossil fuels, this will provide further impetus to green investments, accelerating the structural reduction in oil demand expected in the coming decades.
Therefore, it would be unsurprising if the rift within OPEC+ is repaired in the coming weeks with a fudge on 2022 production targets possibly presented as a diplomatic victory for all parties. It seems reasonable to expect that the production increase discussed by OPEC+ will be broadly implemented and that the UAE will be granted a partial increase in production quotas from May 2022 in exchange for extending the agreement on production limits until at least the end of next year.
In this scenario, a drop in oil prices in the coming months would be expected. This would also reflect the overvaluation of current prices relative to fundamentals that the econometric analysis shows. Starting from an overvaluation situation, our model predicts that the WTI oil price should fall in the coming quarters towards USD60pb, a similar pattern as incorporated in futures contracts.
