OPEC+ meeting outcome scenarios:
1 Reduction in production:
This is highly unlikely given the meteoric increase in prices and the resulting geopolitical pressure to increase production from the US and other countries. However, what is possibly more important is many of the OPEC+ countries would not be keen at this juncture with a seemingly well-supported oil price environment there simply isn’t the need for cuts in their view. The only scenario where cuts occur is in a Covid-surge lockdown resulting in a demand destruction scenario of Q2 2020 and an emergency OPEC+ coordination.
2 No change
The base case view, this is the most likely outcome given OPEC+ caution to not impact the recovery in the oil price to what it ultimately sees as a reasonable level. Given the stepped increase agreed in July, referred to above, it is the most probable favoured outcome for Saudi Arabia. OPEC+ have confirmed that this is their intended path on the 4th October, despite other countries request to increase production. With supply falling well below demand, this still results in a volatile but steady uptrend in oil prices, towards 90 USD/bbl.
3 Higher Baseline
Probably the largest issue for this next meeting will be internal arguments from individual OPEC+ countries requesting an increase in their baselines - this presents the wildcard for the meeting, and certainly a key factor in the heavily debated and delayed outcome in July. The breakeven oil price above highlights the countries most likely to request an increase in their share. The breakeven chart suggests a very contrary problem, for example, UAE was keen for a production increase in July, an understandable request given their breakeven oil price and their investment cycle in oil over the last decade. We feel the question of oil demand destruction resulting from high prices (and not a covid surge), as has been partially witnessed in Natural Gas recently due to the surge in power/natural gas markets seems less likely in oil due to 1) the related oil/coal substitution factor for generating power and 2) the difficulties associated with ICE fuel substitution in the transport sector and refined product consumption. Any increase would likely be very limited 0.5 mbpd or less, which still results in a Q4 market that is undersupplied, causing price pressure to remain stable to upward.
4 Price/volume War
Given the implied weakness in prices this would induce and the effectiveness of the OPEC+ strategy, in their view, this therefore seems a low probability of occurring.
If a new impasse, as in July, leads to an outright price war, we assume that the main OPEC+ producers return to Apr-20 production levels for a quarter and ultimately agree to scenario 2 or 3 above. This would represent up to a $10/bbl downside in prices. However, the impact is more limited compared to April last year given the large current supply-demand deficit.
What does the Option market strike price traded highlight?