Energy - OPEC+ likely to keep output targets unchanged
G-7 nations agreed on a price cap for Russian oil at the end of last week. This is an idea that has been pushed for several months now by the US with the hope that it would offer some relief to the oil market. However, looking at the price action since the announcement (prices have moved higher), it is pretty clear that the market is not convinced that the cap will work. The idea of the cap is to allow buyers to access G-7 and EU insurance and shipping services for Russian oil, if the price is at or below the price cap. However, there are still a lot of obstacles and unknowns regarding the cap. Firstly, EU members will have to accept the proposal and changes will need to be made to the sanctions package. It could be difficult getting all member states to agree to this latest proposal. Secondly, and even if all EU members agree to the cap, G-7 nations need to ensure that buyers are willing to take part in the price cap plan to make it effective. This means that larger buyers such as China, India and Turkey would need to take part. There is no guarantee they will, particularly after Russia has said that it will not supply any country who follows the price cap. In addition, a big unknown is what price level the cap will be set at. It is pretty clear that it will need to be set above Russian production costs, otherwise there is little incentive for Russia to maintain production at current levels. Finally, monitoring and enforcing the price cap will be a significant challenge as well.
While there is plenty of uncertainty over Russian flows, there is also quite a bit of uncertainty over OPEC+ output policy and what the group will decide today at its monthly meeting. Previous comments from the Saudi energy minister suggested that the group may have to cut output due to a dislocation between the physical and paper markets. Several OPEC producers have since echoed these comments. However, we believe that OPEC+ will leave output targets unchanged for next month. It is difficult to justify cutting output when the market is trading near US$100/bbl. In addition, Russia is reportedly against cutting output as it sends the wrong signal to the market about the supply and demand picture. Furthermore, it would make more sense for OPEC+ to wait for further clarity on Iranian nuclear talks before taking any action. These talks appear to have taken a turn for the worse, with the US saying that Iran’s latest response was “not constructive’.
Finally, we are likely to see further volatility in the European gas market this week. And this is after gas flows along the Nord Stream pipeline did not resume over the weekend, following maintenance. Gazprom claims that an oil leak at the Portovaya compressor station means that the Nord Stream pipeline will be fully shut down “until the operational defects in the equipment are eliminated”. Prior to last week’s maintenance, Nord Stream was operating at only 20% of capacity. The halting of flows means that Europe will lose close to 1bcm of natural gas supply per month. The market will now likely become increasingly nervous about flows via Ukraine as well as TurkStream. What is clear is that the more Russia reduces gas flows to Europe, the less leverage they have over Europe.
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