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Commodities Corner: Will OPEC+ fill the gap as Russian oil output falls? Don’t count on it.

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Talk of a potential deal that would let other OPEC+ producers make up the crude supply gap left by Russia has put a lid on oil prices, but it would take much more to bring them down, analysts said.

“Exempting Russia from the OPEC+ output deal and allowing other producers such as Saudi Arabia to pump more might bring some temporary relief to the market, but the lack of sufficient spare capacity represents an increasingly binding constraint at a time of resurging postpandemic mobility,” said Edoardo Campanella, a Milan-based economist at UniCredit Bank, in a Wednesday note.

OPEC+ — made up of the 13-member Organization of the Petroleum Exporting Countries and 10 other major producers, including Russia — is due to hold a regularly scheduled monthly meeting on Thursday. The Wall Street Journal reported Tuesday that some OPEC members were exploring the idea of exempting Russia from production targets.

OPEC+ agreed last year to bump up production in monthly increments, but Russian output is seen falling around 8% this year as a result of sanctions and embargoes by buyers in response to the late February invasion of Ukraine, where fighting continues to rage. The Wall Street Journal article noted that there had been no formal push to exempt Russia and that it wasn’t clear whether Moscow would go along with such a proposal.

Oil futures pulled back from session highs to end mixed following the report on Tuesday. Crude futures were higher in Wednesday’s session, with August Brent crude
BRN00,
+1.96%

BRNQ22,
+1.96%
,
the global benchmark, up $2,02, or 1.7%, at $117.62 a barrel on ICE Futures Europe. West Texas Intermediate crude for July delivery
CL.1,
+2.03%

CLN22,
+2.03%
,
the U.S. benchmark, rose $, or 1.8%, to $116.67 a barrel on the New York Mercantile Exchange.

U.S. stocks were nursing losses to begin June, with the Dow Jones Industrial Average
DJIA,
-0.80%

down around 330 points, or 1%, while the S&P 500
SPX,
-0.91%

shed 1.1%.

An exemption from production increases would reflect the reality that Russia is unlikely to be able to boost output due to sanctions targeting oil exports by the U.S., U.K., and, as of this week, European Union countries, said Robbie Fraser, manager of global research and analytics, at Schneider Electric, in a note.

“While Russian output has proven somewhat resilient so far, output is expected to drop in the coming weeks and months,” he wrote. “That could move Russia into similar status as countries like Libya or Iran who have even been left out of coordinated production efforts due to a mix of political unrest and international sanctions.”

But OPEC+, which has been moving up production targets in monthly increments of 430,000 barrels a day, has continued to struggle to meet them. Analysts have blamed a lack of spare capacity across much of the region due to years of underinvestment.

Saudi Arabia’s oil minister, Prince Abdulaziz bin Salman, in May warned that the world “is running out of energy capacity at all levels,” according to news reports.

Meanwhile, the oil market remains extremely tight, noted UniCredit’s Campanella, a situation not helped by OPEC+’s inability to meet its targets. That will only get worse as Russia’s output falls (see chart below).

UniCredit Bank

Factoring in output losses from Russia and assuming missing barrels from other OPEC+ countries remain unchanged would leave the cartel short of its goal by around 4.5 million barrels a day by July, he estimated. In other words, OPEC+ output would be the same as it was last August. In reality it will likely be lower, the economist said, because with the exception of Saudi Arabia, the United Arab Emirates and Iraq, all other OPEC+ producers have almost no spare capacity and would be unable to boost production as much as needed over the next two months.

Campanella said a deal to exempt Russia from the agreement on Thursday would likely have a short-term, negative effect on crude prices, but would be unlikely to last. Only scrapping the OPEC+ quotas altogether and a renewal of Iran’s nuclear accord would be sufficient to bring the market back into balance, he argued.

The math works like this, Campanella said:

Overall, the spare capacity of OPEC+ (ex-Russia) is 4.2mb/d. If it was fully released overnight (practically complicated), it would barely compensate for the missing barrels expected in July…But, at that point, OPEC+ would no longer be able to add additional barrels as it will have exhausted its entire production capacity. Considering that global demand is expected to rise by 2.2mb/d throughout 2H22 and non-OPEC+ production is expected to increase by around 1.3mb/d, then the world would be short of 1mb/d. Only a quickly signed Iranian nuclear deal could compensate for the shortfall and rebalance the market.

That reality, combined with the potential negative spillovers from the Russia-Ukraine war on the natural-gas market as winter approaches means the risk of Brent holding within the $115-to-$125-a-barrel trading range for a longer period has increased substantially, along with the potential for a spike to $130 a barrel, Campanella said.

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