Oil prices posted their biggest monthly loss of the year in August, despite expectations that major producers may be ready to consider cutting production at the next meeting of the Organization of Petroleum Exporting Countries and its allies, known as OPEC+, on Sept. 5.
“The oil market has been sensitive to any news that would suggest a meaningful imbalance between supply and demand,” says Chris Duncan, director of investments at Brandes Investment Partners.
At the last OPEC + meeting, on Aug. 3, the group agreed on a modest 100,000 barrel-per-day production increase for September.
In March, West Texas Intermediate and Brent crude prices topped $130 a barrel following Russia’s invasion of Ukraine, but have since fallen. WTI prices, for instance, ended August under $90, after sharp drops this week. Prices for WTI
the U.S. benchmark, were down about 9% in August, while Brent
the international benchmark, fell some 12%.
Early in 2022, “demand growth was robust, and there were meaningful supply concerns surrounding Russia,” says Duncan. Since then, significant supply disruptions of Russian oil have failed to materialize. Meanwhile, concerns over Iran’s nuclear program could lead the West to ease sanctions on Tehran, allowing it to contribute more oil to the global market.
As a result, in less than six months, the oil market has “gone from the potential negative supply shock of losing Russian production to possibly not losing much Russian production and adding production from Iran,” says Duncan.
At the same time, the outlook for oil demand has weakened. Data now suggest that some economies around the world appear to be in recessions, says Jeffrey Whittle, a partner focused on the energy sector at law firm Womble Bond Dickinson. U.S. gross domestic product fell for a second straight quarter in the April to June period, which some argue indicates a recession.
Against that backdrop, OPEC’s biggest producer, Saudi Arabia, recently suggested that the group may consider an output reduction.
By potentially cutting back production, OPEC+ is able to “send a message that prices will remain relatively higher…for the foreseeable future,” at least above the $55 to $60 range, which is often thought of as the “at least” pricing target for some of the OPEC+ economies, says Whittle.
There is a scenario where OPEC production cuts become prudent in the “not-too-distant future,” says Duncan. It’s “hard to say,” he adds, how likely that scenario is, but Saudi Arabia may want to remind the U.S. that a deal with Iran “will not guarantee an increase in oil supply.”
However, potential changes to supply, whether it comes from OPEC+, Iran, or the U.S. Strategic Petroleum Reserve, are just “drops in the bucket” compared with one key, overlooked factor, notes Salem Abraham, president of Abraham Trading, which manages the Abraham Fortress fund
There’s a “lack of reinvestment in drilling new oil wells,” he says, in part due to the rising cost of drilling, which has led to the need for higher break-even oil prices, he adds. There are only about 655 oil rigs currently drilling worldwide, with oil prices close to $100 a barrel, he says. But when prices were around $60 in December 2019, some 825 oil drilling rigs were active.
“ “The slingshot demand will catch the supply side flat-footed, resulting in a large price spike” to $200 oil and $10 a gallon gasoline.”
That “disconnect” is the key reason for his belief that oil will climb to $200 in the next nine to 18 months.
Getting back to prepandemic production levels will require new wells, says Abraham. “The slingshot demand will catch the supply side flat-footed, resulting in a large price spike” to $200 oil and $10 a gallon gasoline, he predicts.