Oil Prices Fall During Crucial OPEC Meeting - Barron's

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Back in April, OPEC’s decision to cut production sharply saved the oil industry from a much harsher drop. Now, the cartel faces another complicated decision: whether to begin restoring production to more normal levels or to extend the cuts and buoy prices for a few more months.

A week ago analysts had been convinced that the cuts would be extended for at least three more months, but that certainty appears to be slipping -- and with it, the price of oil. Early disagreements among the group were reported on Sunday, and an Iranian oil minister told a local journalist that the differing opinions “makes it difficult” to come to a deal.

Brent crude futures, the international benchmark, fell 1%, to $47.70 a barrel on Monday. West Texas Intermediate futures fell 0.7%, to $45.22.

Oil stocks were down too, with refiner Valero Energy (ticker: VLO) dropping 3% and Exxon Mobil (XOM) falling 3.2%.

OPEC and its allies -- a group known as OPEC+ that includes Russia -- agreed in April to cut 9.7 million barrels worth of production. Saudi Arabia agreed to even more reductions. That took more than 10% of global production off the market as lockdowns sapped demand for oil.

OPEC tapered those cuts to 7.7 million barrels in August, and is set to taper again to 5.7 million in January. But the resurgence of Covid-19 in several spots around the world has led oil demand to fall again, and has raised questions about whether it’s time to restore production yet.

Oil prices have recently rallied on expectations that vaccines will be distributed widely by the middle of next year. But demand remains subdued and there is a high probability that supply will outstrip demand for the next several months at current rates. Oil has once again been piling up in storage tanks at the key U.S. hub of Cushing, Okla.

OPEC faces a game theory problem, notes Paul Sankey of Sankey Research. If members continue to keep production low, U.S. and other non-OPEC producers are likely to increase production and take market share, at least in the short term. But if OPEC increases production, it could cause prices to drop significantly, hurting all producers -- including themselves. Sankey expects OPEC to agree to extended cuts, out of fear of a price drop.

“We think extending cuts on weakness is more likely,” he wrote on Monday. “Ministers may represent governments that may fall—or perhaps less dramatically cost them their jobs—if oil prices stay under $40 per barrel. Notably Nigeria and Iraq have considerable social unrest at this time. Budget break-evens for OPEC members are on average around $80 per barrel Brent.”

This is a particularly important meeting because oil prices have finally climbed above break-even prices for many U.S. producers. The difference between $45 oil and $40 oil is the difference between producing free cash flow and just getting by. A drop in prices would quickly hurt U.S. producers.

Rystad Energy estimated that oil would begin building up in storage tanks quickly if OPEC restores 2 million barrels a day in January. That would cause the market to buckle. But a six-month delay could give oil another major boost, one that could vault stocks higher in a hurry.

“We believe keeping the current agreement in place—which calls for raising target production by 1.9 million barrels a day from January 2021—could send Brent back down to $40 per barrel or lower,“ says Bjørnar Tonhaugen, head of oil markets at Rystad Energy. “A three-month extension would only provide marginal support to prices, but would help to establish $50 as a sturdier floor, while a six-month extension could help to meaningfully deplete the storage overhang and supercharge prices into the mid-$50s.”

Write to Avi Salzman at avi.salzman@barrons.com

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