Weekly Hard Assets Insights
By David McAlvany

High Stakes for OPEC+

Amid a roaring recovery in the price of crude oil over the last year, this week saw significant volatility return to the oil patch. Much of the volatility revolved around the uncertainty that came from a repeated failure of OPEC+ members to agree on new oil production levels and export quotas.

Expectations were that OPEC+ would agree to marginally increase production and continue to trim back deep production cuts that were enacted in the depths of the global Covid economic shutdown. Those cuts amounted to 9.7 million barrels a day as the global economy ground to a halt.

As the vaccine push has gained momentum, government restrictions are being lifted, and the global economy is restarting, OPEC+ has been increasing production, but at a measured and deliberate pace. So far, OPEC+ has increased production by four million barrels a day from trough levels. Going into the latest round of talks, many analysts believed that any agreement for production increases at around 500 thousand barrels per day or less would be bullish for crude prices.

Over the last year, the oil price “ball” has been seen as being increasingly in the court of a strong and unified OPEC+. There are a number of reasons for this, but two of the most notable are environmental activism constraining new oil industry cap-ex spending and numerous shale oil producers that are financially encumbered after suffering from bad price hedges agreed upon at much lower oil prices in the teeth of the pandemic.

The net effect has been that OPEC+’s power in the market has increased. The logical assumption on the part of the market has been that OPEC+ would relish it’s opportunity to exercise that influence and drive prices higher to benefit all of it’s members. Up until the latest round of talks, that was exactly what happened.

When news broke that OPEC+ members had failed to reach an agreement on production increases, it initially caused a rally in the price of crude. No agreement implied no added production. As more news came out, however, analysis of the situation became more complicated. Reports revealed that the failure to reach an agreement came from a standoff between Saudi Arabia and the United Arab Emirates (UAE). Saudi Arabia, as the dominant member of OPEC+, is on the side of maintaining group discipline and supporting strong crude prices. The UAE, on the other hand, now seems to be breaking ranks in the direction of a new strategy.

The UAE’s new strategy is potentially a dangerous one for OPEC+. Rather than maintaining discipline aimed at the long-term benefits of higher crude prices for all member states, the UAE is shifting it’s preference toward maximizing the monetized value of its substantial oil reserves in the near term. A source reportedly briefed on the UAE’s strategy was quoted by the Wall Street Journal as saying “This is the time to maximize the value of the country’s hydrocarbon resources, while they have value.”

This development is a crack in OPEC+ member unity, and affects the viability of the oil long game. The UAE apparently views its substantial oil reserves as a means to diversify the state’s economy towards new revenue streams that include alternative sources of energy.

The Wall Street Journal adds that the UAE’s strategy shift “represents one of the most significant shifts in oil policy by a major Mideast petrostate. For years, the region’s oil producing governments have said they aren’t worried about finding crude buyers far into the future.”

In the latest talks, the UAE is the only member withholding its agreement to boost production. It has, instead, made its agreement contingent upon its own ability to boost its relative output within the group’s internal quota system. This week, the Saudi-led group of OPEC+ members has refused to play along with the UAE’s maneuvering. Thus, no production increases have been agreed upon yet.

There is no question that the UAE’s position could be far less dramatic than is being described. There is every possibility that it’s just an aggressive negotiating tactic to optimize the UAE’s production and state revenue. If, however, the actions of the UAE are taken at face value, it is easy to see just how quickly OPEC+ unity and strength could crumble and devolve into an every state for itself free-for-all, with dramatic implications for international relations, geopolitical structure, and everything energy related.

The likelihood is that OPEC+ unity will prevail. Still, uncertainty will equal volatility given that any meaningful breakdown in the unity of member state agendas introduces a dizzying array of potential outcomes that many market participants have yet to grapple with.

As for weekly performance: The S&P 500 closed the week up 0.40%. Gold was up by 1.53%, while silver was down 1.02% on the week. Platinum was up 0.74%. Palladium also gained, up 0.70%. The HUI gold miners index was off 0.51%. The IFRA iShares U.S. Infrastructure ETF was down 0.17%. Energy commodities were mixed in a volatile week. Oil was down 0.80%, while natural gas prices were nearly flat, up 0.03%. The Commodity Research Bureau Index lost 1.47%, while copper was up 1.64%. The Dow Jones U.S. Real Estate Index ended the week up 2.58%, while the Dow Jones Utility Average Index gained 0.95%. The dollar gained 0.62% to close the week at 92.41. The yield on the 10-year Treasury lost another 7 bps to close the week at 1.37%.

Have a wonderful weekend!

Best Regards,

David McAlvany
Chief Executive Officer
MWM LLC