Oil poised for supply tightness on seasonal demand, likely OPEC+ move

Global oil markets are likely to witness some supply tightness in the second half of 2024 on growing expectations that OPEC and its allies will roll over their production cuts when they meet in early June, while robust seasonal demand could pull down crude inventories.

These factors, in addition to turbulent geopolitics in the Middle East, might put a floor on oil prices for now.

The OPEC+ ministerial meeting is scheduled to take place virtually on June 2 amid mounting tensions over quota compliance and potentially complicated discussions over each country's production capacity.

The group will be meeting to decide future output levels, with current quotas set to expire at the end of June.

However, the talks may prove challenging, with tension brewing over compliance with quotas. Iraq and Kazakhstan have already been forced to release compensation plans involving additional cuts to make up for overproduction in early 2024. Both reduced output month-on-month in April but continued to produce above their caps.

Overall, OPEC+ countries implementing cuts produced 249,000 b/d above quota in April, according to a Platts survey by S&P Global Commodity Insights. Talks over baselines from which quotas are set could cause further conflict.

Putting a floor on prices

OPEC and its Russia-led allies have made several rounds of production cuts since October 2022 to put a floor under prices, with the most recent tranche involving some 2.2 million b/d of voluntary cuts by several members from January through June.

However, some members may not be very keen to increase production unless oil surpasses the $100/b level, while others may prefer to raise output at lower prices, especially if they expect their production capacity to rise in 2025. The need to maintain unity and achieve a consensus will determine whether output is altered from the current levels.

According to Commodity Insights, the base case scenario is that current quotas and voluntary cuts will be extended and support prices in the $85-$95/b range. However, in a case where unity may need to be preserved, production could be raised even if oil is below $100/b. This could set the stage for weaker-than-expected prices. Voluntary cuts -- which total 2.2 million b/d from eight countries -- may be curtailed before groupwide quotas are adjusted.

Dated Brent is projected to average $91/b from May to December this year. And for the whole of 2024, price forecast for Platts Dated Brent has been revised up by $4/b from last month to $89/b.

A related OPEC+ exercise will unfold after the June meeting -- determining 2025 country-level production capacity to be used for 2025 reference production levels. Most large OPEC+ producers expect their production capacity to rise in 2025. This could fuel a move to raise production this year and in 2025, as US oil production continues to grow.

Situation could change

Although availability of crude is relatively comfortable as of now, but some of the likely developments in the foreseeable future have the potential to alter the existing scenario.

Currently, the Organization for Economic Co-operation and Development's commercial crude oil inventories are slightly below their five-year average. Global commercial crude stocks, including oil on the water, are higher. And there is about 5 million b/d of unused oil production capacity in the Middle East, compared with 2.6 million b/d two years ago.

However, Commodity Insights expects crude oil stocks to decline for several months beginning June, as global demand seasonally increases by 3.6 million b/d from April to August and OPEC+ extends cuts.

In addition, the ongoing conflicts in the Middle East and Ukraine can fuel geopolitical price premiums. There is ample unused production capacity and growing supply outside of OPEC+.

The escalation in hostilities between Iran and Israel has not affected oil flows, although the risk of an impact on oil is higher. The US discourages attacks on oil facilities in the Middle East and Russia, as President Joe Biden is concerned about inflation and gasoline prices in an election year.

Refinery markets are tighter than crude and there is no equivalent spare capacity like crude. According to Commodity Insights, this will keep margins supported even as refinery outages decline and utilization rises.

Weakness in diesel markets has emerged but it might be temporary as the market enters the summer demand season. Gasoline and fuel oil cracks should undergo a seasonal upswing in coming months as well.

Asia eyeing developments

In response to the Iranian attack on Israel earlier this month, the US enacted the Stop Harboring Iranian Petroleum (SHIP) Act, which authorizes mandatory sanctions on foreign ports, vessels and refineries involved in the trade of sanctioned Iranian petroleum products.

The bulk of Iranian crude oil exports currently go to the Chinese independent refiners, often at steep discounts. Going forward, the impact on Iranian crude oil flow to China will hinge on how the US executes and enforces the sanctions.

Ship-to-ship transfers that are targeted by the SHIP Act will be difficult to track if ships shut their automatic identification systems in the open sea. However, there may be disruptions to Iranian barrels flowing to the Chinese independent refiners if Malaysia, which is usually stated as the origin country for the blended crude barrels, stops issuing the required certifications.

Oil markets will also be watching closely how the death of Iranian President Ebrahim Raisi, who was killed in a helicopter crash May 19, would impact the country's oil policy as well as the region's geopolitics.

Iran exported around 1.5 million b/d of crude oil in the first quarter of 2024, with most heading to China, according to Commodity Insights data.

In addition, with the reimposition of US sanctions on Venezuela's oil and gas sector, more Venezuelan barrels are expected to flow to China as India stops its intake. Venezuelan crude prices are expected to come down further following the restoration of the sanctions, making them more appealing to the Chinese buyers.

A version of this article was first published on Energy World from The Economic Times