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Commodities Corner: Don’t expect any surprises from OPEC+, even as recession worries weigh on oil prices

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Oil is among the biggest commodity gainers of the year as global supplies remain tight, but the potential for a recession threatens demand as major producers prepare to make another decision on output levels.

So far this year, U.S. benchmark West Texas Intermediate
CLQ22,
+3.76%

CL.1,
+3.76%

crude trades around 39% higher and global benchmark Brent crude futures
BRNQ22,
+3.19%

BRN00,
+3.09%

has climbed by more than 40%, as of Thursday. The S&P GSCI Energy index boasts a roughly 50% gain for the year.

Oil supply is “very tight, and getting tighter,” says Darwei Kung, head of commodities and a portfolio manager at DWS Group. About 2 million barrels a day of Russian oil and refined-product supplies are likely “stranded at the moment from either official or voluntary sanctions.”

U.S. production, meanwhile, hasn’t climbed back to pre-Covid-19 levels as pandemic-related labor shortages and supply-chain constraints take time to be resolved, Kung adds.

At current prices, the energy industry should be seeing significant capital investments, but increased regulations, tariffs, and the protectionist policies of some governments “inhibit the free flow of capital,” says Taylor McKenna, an analyst at Kopernik. That’s contributed to tight oil supplies and suggests high prices may continue.

Some members of the Organization of the Petroleum Exporting Countries, such as Saudi Arabia and the United Arab Emirates, have the ability to raise production. Overall, however, OPEC and its allies, together known as OPEC+, have failed to collectively reach their production targets.

OPEC+ underproduced its output target by 2.616 million barrels a day in May, according to a report from S&P Global Commodity Insights. There is “very limited spare capacity in the Middle East, and none outside the Middle East,” says Pavel Molchanov, an analyst at Raymond James. Iran has the most spare capacity, but it’s subject to sanctions, he says.

President Joe Biden will visit the Middle East next month, including Saudi Arabia—where he plans to discuss energy security. His visit will follow the OPEC+ production level decision on June 30. At the June 2 meeting, producers agreed to raise their collective output target in July and August by 648,000 barrels a day each month, compared with the 432,000 barrel-a-day monthly increases they have made since last year.

The European Union is set to implement a ban on nearly all Russian oil imports by the end of the year. For now, however, China and India have raised their purchases of oil from Russia.

OPEC members will “undoubtedly factor an economic recession into demand forecasts, but given a tenuous supply/demand balance, we don’t believe there would be a change to production levels to defend price,” says David Deckelbaum, senior analyst at Cowen.

Chinese demand is expected to rebound in the fourth quarter from Covid-related lockdowns, and there’s a greater risk to the upside for crude prices beyond the $125 level, he says, though “concerns around recessionary demand slowing could temper those moves.”

Rising inflation has been more of a concern as U.S. drivers face record-high gasoline prices, with Biden calling for a temporary suspension of federal gasoline taxes. Analysts at DWS are reassessing the impact of inflation and interest-rate decisions by major central banks, but for now, they forecast WTI crude at $110 a barrel by the end of June 2023, from prices of around $104 on Thursday.

“We still expect to see a wide range of crude prices going forward,” says Kung. A deal with Iran to resume oil production to pre-sanction levels can replace missing barrels from Russia, he says, while the “trajectory for demand could also be altered by more aggressive central bank measures globally.”

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