Why the oil market likes the OPEC+ deal but prices don’t show it

The oil market is happy with the OPEC+ decision to gradually lift production further starting next month, but the sharp price move lower on Monday certainly didn’t show it.

“Declining demand growth could deflate the rally,” Marshall Steeves, energy markets analyst at IHS Markit, told MarketWatch, as the OPEC+ agreement has come “just as the Delta variant is spreading, and leading to concerns with the implications for global demand growth.”

Last week, U.S. benchmark crude prices had climbed to their highest level since 2018.

OPEC+ energy ministers announced on Sunday, however, that oil production will increase by 400,000 barrels a day each month beginning in August and would eventually undo all of the output curbs put in place last year in response to the COVID-19 pandemic. The United Arab Emirates, along with some other members of the group, will have higher baseline production levels starting in May 2022.

“With the deal settled, investors now have greater clarity regarding oil supply over the near-to-medium term,” analysts at UBS wrote in a research note dated Monday. “The attention of investors should now pivot back toward the economic reopening.”

That reopening, however, has been clouded by the global rise in COVID-19 cases, raising the possibility of renewed economic restrictions that would hurt demand for oil. The global tally for the coronavirus-borne illness climbed above 190.5 million on Monday, while the death toll climbed above 4.09 million, according to data aggregated by Johns Hopkins University.

It’s difficult to anticipate future demand growth from here, said Arnim Holzer, macro and correlation defense strategist with EAB Investment Group, but we “see the U.S. reopening strength as likely to still outstrip supply.”

The COVID-related concerns supporting the rise in U.S. dollar
meanwhile, “could run out steam at some point in the coming months,” which would support crude and commodities prices in general, he said.

For now, prices on Monday were sharply lower, with August West Texas Intermediate crude

down $4.84, or 6.7%, at $66.97 a barrel and September Brent crude

losing $4.46, or 6.1.%, to $69.13 a barrel.

The potential for “new widespread social [and] travel restrictions, reducing demand for oil,” are only partly to blame for the losses in oil prices, said Jeff Klearman, portfolio manager at GraniteShares, which offers exposure to oil through the GraniteShares Bloomberg Commodity Strategy No K-1 exchange-traded fund

The Energy Information Administration report released Wednesday showed a weekly increase in gasoline inventories, even as a drawdown was expected, raising concerns that demand for the fuel may have peaked. Klearman pointed out that “the increase occurred over July 4th weekend, typically a time of heavy demand.”

Meanwhile, an increase in the number of active oil rigs in the U.S. and an uptick in shale oil production has “reintroduced supply-side concerns,” he said. Baker Hughes
on Friday reported a third-straight weekly rise in active U.S. oil drilling rigs, implying future production increases.

There are also expectations that the Federal Reserve and other central banks will “need to tighten monetary policy sooner rather than later,” causing economic growth to slow and decreasing demand for oil, said Klearman. Concerns also remain surrounding additional supply from Iran, should a nuclear agreement be reached between world powers and Tehran— relaxing or removing sanctions, allowing Iran to contribute more oil to the world market.

WTI oil prices are up by almost 50% year to date, and a “retrenchment from current levels in light of these new concerns is understandable,” said Klearman. “Continued good economic growth, and hopefully waning COVID concerns could certainly increase demand expectations and move prices higher.”

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