OPEC+ is likely to maintain its strategy of adding 400k b/d per month until at least the end of 2021 when it meets later this week. Oil prices have recovered from a recent dip to less than USD 65/b in Brent futures to more than USD 73/b by the end of August even as economic data—such as the weak August China PMI numbers—highlight the threat to growth poised by the spread of the delta variant of Covid-19.
The recovery in oil demand will likely move down a gear in the final months of 2021, caused as much by a return to near pre-pandemic levels of consumption as by negative shocks caused by outbreaks of the delta variant in major economies. Nevertheless, demand should still be strong enough to help keep oil market balances in deficit and see inventories draw down. The trajectory of the pandemic remains the dominant factor affecting oil demand in the near term. Governments globally are taking different tacks to deal with the second year of Covid-19 but more and more are choosing to “live with” the virus and reopen their economies more fully, thanks in large part to vaccinations. The rollout of vaccines, which will help to spur consumer and business confidence, still has a long way to go globally but as more of the global population is inoculated, one negative demand risk should be removed from oil markets. Stringent lockdowns that hamper mobility and negatively impact oil demand are still in use in some marginal markets or have been used for brief periods by economies like China or India but we do not expect to see a full scale halt to activity like the global economy endured in Q2 2020.
Shipping and air travel remain the major downside risks for oil demand in the near term with neither expect to reach pre-pandemic levels, even by 2022. Disruptions affecting shipping, either from infection outbreaks at ports or lack of capacity, will remain a structural drag on oil demand while the rebound in jet fuel demand will be entirely contingent on government policies related to quarantine and isolation.
None of these demand variables will be unknown to the OPEC+ policymakers who meet this week and by committing to their plan announced at the end of July to add 400k b/d on a monthly basis they can send a signal of confidence to oil markets. We would thus expect the pattern that we saw oil prices endure in August—moving in wide swings around USD 65-75/b in Brent markets—to likely play out over the remainder of 2021 as markets price in the spread of the virus, government responses, vaccine rollouts and general economic activity.
For 2022, however, the outlook is undoubtedly more uncertain. Oil demand, projected by the IEA, is set to get close to pre-pandemic levels and consumption growth will slow substantially by H2 2022, to just 2m b/d on average compared with more than 5.3m b/d expected for this year. Additionally, non-OPEC supply will recover all its lost output by the end of 2022 with the IEA projecting supply of 67.4m b/d by Q4 2022, higher than the 66.8m b/d recorded in Q4 2019.
With a moderating demand picture and a positive supply response from market-oriented producers in countries like the US and Canada, the OPEC+ plan to rigidly add 400k b/d each month until at least September could end up tipping oil market balances substantially into surplus next year. And with higher baseline levels for major producers to take effect from May 2022, the annual individual increases in volume may be enormous: the UAE could be on track for a 14% increase in oil output and Saudi Arabia almost 18% if they stick to the 400k b/d per month target.
While those figures may help flatter headline real GDP growth numbers and fiscal and external balances, adding 1.2m b/d each quarter next year could risk oil prices pushing substantially lower. OPEC+ gave itself a carveout in its July 2021 deal, noting that it will maintain the OPEC+ ministerial meetings to decide output levels each month. Should OPEC+ producers worry that they will be directly contributing to an oversupplied market from the start of 2022, we would expect them to adjust their targets quickly to try and keep oil markets closer to being balanced.
We have long noted that monthly meetings for a bloc that controls around 50% of global oil supply risks exacerbating volatility in energy markets and a decision to scrap the monthly increases in response to declining prices could actually worsen downside risks. OPEC+ may try to communicate any walk back of its planned additions as responding to “market conditions” but markets may equally interpret it as panic and a lack of confidence in the sustainability of oil demand.
Our oil price assumptions for 2022 are for prices to drift lower to an average of USD 65/b for Brent, compared with closer to USD 68/b in 2021. That may not appear a material difference but with plans for supply additions as they stand at the moment, our target for Q4 2022 is an average of just USD 60/b, implying some considerable time well below fiscal breakeven levels for nearly all OPEC members. As the outlook for demand and non-OPEC supplies in 2022 becomes clearer, we will reevaluate our expectations for oil prices next year. But for now we expect a downward drift as the most likely outcome.
