$70 Oil Won't Keep OPEC Happy

Oil prices plunged on Friday on renewed fears of a COVID-19-fueled drop in demand.

OPEC has been slow to open the taps despite soaring oil prices over the past several months.

The latest drop in oil prices plays to the cartel’s concerns over oil demand in the near to medium term.

One day—that was all it took oil prices to plunge by more than a tenth after health authorities announced the identification of the latest potentially dangerous coronavirus variant in Southern Africa. Brent crude dropped from over $80 to about $72 per barrel, and West Texas Intermediate fell to $68 per barrel in the space of less than 24 hours, days after prices reacted to the release of 50 million barrels from the U.S. strategic petroleum reserve by rising. And with Brent at $72, OPEC is almost certain to halt its policy of supply increase.

“It obviously remains a wide-open question whether this new variant will truly pose a material threat to oil demand, with vaccination rates ratcheting steeply higher since the summer,” Rory Johnston, managing director of research firm Price Street, told the Financial Times. “But markets aren’t waiting to find out. Sell now, ask questions later.”

This selloff is playing to OPEC’s concerns about oil demand, voiced recently and likely to be part of preparations to announce a halt to the monthly addition of 400,000 bpd to the total OPEC+ oil output until it returns to pre-pandemic levels. The group never managed to add 400,000 bpd anyway, as some members struggled to boost production.

OPEC now has more than one good reason to pull supply back. First, the U.S. reserve release move, which also involved other large oil consumers that happen to be Washington’s allies, had no chance of being welcomed by the oil-producing cartel. In fact, reports emerged almost immediately after the SPR release announcement that Saudi Arabia and Russia, the leaders of the extended OPEC+ alliance, were already considering a suspension of the output boost policy.

Citing unnamed sources familiar with the matter, the Wall Street Journal wrote on Wednesday that the two largest oil producers in the group were inclined to pause the output additions, while others, such as the UAE, saw no reason for a change in tack. After Friday’s price drop, this opinion may have changed.

Then OPEC went on stoking expectations of a suspension: the group’s Economic Commission Board—an advisory body within the organization—said this week the oil stocks released by the United States and its partners would swell a global oil surplus by some 1.1 million bpd in January and February, according to a document that Bloomberg cited.

If 66 million barrels were added to global supply by the U.S. and its allies, OPEC’s ECB said in the document, the global oil overhang would rise to 2.3 million bpd in January 2022 and 3.7 million bpd in February. Add to this the latest Covid scare, and the halting of output additions is all but a done deal. And it might not end with the halt of the 400,000-bpd in additions.

“I think as we head into the OPEC meeting Thursday, the question is not only do they do a pause but potentially will they actually pull back some barrels because of concerns about this new variant alongside the very large SPR release,” said Helima Croft, RBC Capital Markets’ head of global commodities strategy, as quoted by CNBC.

“We are going to have a lot of barrels hitting this market, as we have these concerns about new Covid lockdown restrictions,” Croft also said. “Again, too soon to say whether governments will pull the trigger on such measures, but the market will be concerned.”

Earlier last week, a Rystad Energy analyst described the current situation as a “new and unchartered type of price war,” pitting consumers versus producers. Other analysts noted that the producer club held all the cards, however many barrels consumers released. They still hold all the cards, and their hand is on the oil tap, ready to turn it off.

John Kilduff from Again Capital predicted that OPEC will make its move if WTI falls below $70: “The battle lines are being drawn,” he told Bloomberg last week following the SPR release announcement. “Certainly, OPEC and the Saudis can win this in that they are holding all the cards. They can keep more oil off the market than a SPR release can put on the market. If you see WTI get under $70, then I would expect a response from OPEC+.”

This potential response would hardly come as a surprise in light of the latest on the coronavirus. The new strain, according to recent reports, has already reached Europe, with the UK, Germany, Belgium, and Italy confirming the detection of the new variant. With the continent already on high alert because of rising cases, even in countries with high vaccination coverage, the news would only reinforce fears of more restrictions that would affect oil demand. And the virus appears to be traveling fast.

What the latest events have proven once again is that the pandemic remains the biggest single factor for oil prices. Almost two years in, the identification of new variants and flare-ups in case numbers in key oil markets are still better at reining in oil prices than the deliberate actions of governments.