Opec looks to increase output amid rising oil prices

‘Prepare yourself for a more expensive South Africa and a more expensive world. But it won’t stay so for much longer’: Nick Kunze, Sanlam Private Wealth.

FIFI PETERS: All eyes are presently on the Opec and Opec Plus oil cartel, the Organisation for Petroleum Exporting Countries, which is responsible for around 40% of global oil supply. Members have been meeting this week and we are expecting them to come out with a decision on what they’re likely to do, given the oil price environment we’re finding ourselves in with Brent crude at its highest level since 2014.

Will they stick to their current pace of increasing oil production, or will they ramp things up a little bit more, given how oil prices have increased in the recent while?

Let’s get the view of Nick Kunze, a portfolio manager at Sanlam Private Wealth. Nick, so many reports have got around so far regarding what Opec may or may not do. What do you think?

NICK KUNZE: Well, I can tell you exactly what I think, because I can tell you what they said. It lasted only a couple of days and I’m actually quoting one of the financial channels.

It took 16 minutes to come to a conclusion with Opec today.

I think it’s a new world record and the end result is they did agree to raise [by] 400 000 barrels a day, which was largely expected although, given an oil price close to $90/barrel, I think the market was looking for a little more just to ease the pressure. But unfortunately no oil relief for us or consumers anytime soon.

FIFI PETERS: What does this 400 000 barrels a day mean? Isn’t this the pace at which they were increasing initially?

NICK KUNZE: Pretty much. I mean, they have been increasing it quite conservatively for a while now. This is where it was initially about eight or nine months ago. But the problem you’ve got is, as the economy is opening up, as there is more migration to green energy, people are actually struggling to keep up.

Some of the Opec members, if you look at the breakdown, actually haven’t been producing as much as they even want to produce. So they’ve also got a shortage, as well as trying to get it on stream quickly enough. So again, this is not going to go away in a hurry.

FIFI PETERS: Why is that? Is it a case of maybe operational disruptions because of the pandemic that’s limiting them from producing as much as they’d like, is it their strategic decision because obviously in doing so you keep the oil price elevated at these levels, or maybe under-investment in the broader operational value chain? Why are some countries not producing to their maximum?

NICK KUNZE: I think conspiracy theories are out there. Obviously it suits them not to get oil back down at $50 barrel. We all could be cynics about it, but I generally think with the lockdowns and airplanes not flying, and all the rest of it, they cut back so much that with some of these oil-producing rigs and the stuff that sits in the Gulf of Mexico you can’t just flick a switch and turn it from 100 000 barrels a day to 500 000 barrels in an hour.

It literally takes weeks and weeks to get this sort of capacity back up again.

They’re trying to balance the capacity with the demand as economies open up.

I think there is a concern from Opec members that if we do get another variant – heaven forbid – and we lock down again, well, then we’re back to square one. So it’s a real balancing act. Some places closer to home, even like Nigeria, couldn’t even increase by 250 000 barrels a day, which is quite remarkable. They should easily be able to do that.

Cynics aside, you could argue that maybe they are holding back; but overall I think there is this concern that we actually aren’t going to be able to meet demand. Hence the oil price drew stubbornly near $90 today.

FIFI PETERS: What is interesting is that, despite all the action that we have seen in the oil price, and despite the economic reopenings and the increase in demand of late, oil demand is still not at pre-pandemic levels – although that is expected for later on in the year, I see.

NICK KUNZE: Spot on. They are forecasting that roughly halfway through this year, maybe later in the second half – let’s call it August/September – we will eventually hit the pre-pandemic level which I think was around about four or 4.2 million barrels per day. So that’s what we’re gunning for and that’s what we are doing.

It’s not too far away but, as I said, there are so many unknowns. Then, what we’ve seen in the last two years, there are so many things [and] we just don’t know what’s going to happen. So, once again, a bit of balancing but I think we’ll get there. Maybe there is some relief in the second half of this year, if we hit those pre-pandemic levels in demand.

FIFI PETERS: Just on those unknowns and the risks and the uncertainties that they’re looking at, which are preventing them from perhaps acting a lot more aggressively in increasing production – you did mention the variants and the fact that we don’t know which other variant may come and how that plays, what impact that has on supply-chain bottlenecks – just help me understand the inflation profile. What does all the central bank action that may be forthcoming to counter inflation mean for the world of oil?

NICK KUNZE: Well, it should be very positive. History will tell you at the time that actually the biggest beneficiary of an higher inflation environment is energy; well, also things like gas and natural gas prices as well, which we’ve actually also seen ratchet up quite significantly.

So the end result in a higher inflation environment is that oil is going to benefit, along with all other commodities, and it will probably benefit the most. Therefore the cost of everything is unfortunately going to go up.

But this is where the central banks come in. Again, like Opec, they’ve also got a balancing act because they need to curb inflation and bring it down. We had some numbers out of Europe today. I’m sure you would’ve seen record inflation over in Europe, not just in America. The easiest tool is just to raise interest rates from the historically low levels which we see here in South Africa – two back-to-back ones, and probably more to come. So that’s what’s going to happen.

It is a bit of a lagging effect, but ultimately if they do curb inflation, the price of oil will come down – but it is a bit of a long game.

FIFI PETERS: With the geopolitics and the tensions that have followed there – I think last week they had an even bigger impact on oil prices, where we reached almost $92/barrel or $91.7, call it that – we’ve [seen] some of those levels since then, but everyone’s talking about $100/barrel, and are we going to reach it this year? We may reach it this year. Just in your view, what could get us there?

NICK KUNZE: I think it is possible. What could get us there, I think, is a little bit of a premium from it. There’s certainly a conflict in the Ukraine with Russia, I think you’re right. There certainly will be a sort of a war premium built in, probably $10, which gets us to $100.

At the moment it doesn’t look like the case, though. I think they’d be reluctant to go to war and they’re going to try to solve the problems, but there’s no doubt about it. A large portion, Russia, as we know, is an Opec member. It does supply large parts, certainly of places like Germany. All of Germany’s energy needs come from Russia in some shape or form. So Mr Putin is certainly holding a lot of the cards.

If they don’t resolve anything, it is going to add to that sort of price of oil. But then on the flip side to that, Fifi, if we do get a quick resolution and Russia decides to retire back to Moscow and not cause trouble, we could easily get an oil price down $10 or $15, which would be great.

So, once again, it’s one of those ones you have to keep an eye on. There are things like geopolitical risk. Unfortunately, you can’t really price them in business; anything could happen.

FIFI PETERS: Definitely. Wouldn’t that be nice – some relief at the pumps?

Lastly, we’ve been told as motorists to buckle up, buckle up, for some time now in terms of watching our budgets. How long should we be buckling up for, when it does come to what the oil price means?

NICK KUNZE: I’m laughing because it’s so depressing. Yeah, life is going to become expensive for South Africans, for everyone. Inflation is not a nice place to be.

Quite frankly, we are almost lulled into a false sense of security because we haven’t had inflation for so long. It’s been a better part of a decade. We just haven’t had inflation. Even in South Africa, with the 3% to 6% band that the Sarb always referred to, we were under their 3% band for years, and that’s coming along quickly.

So there’s good news and bad news. The bad news is prepare yourself for a more expensive South Africa and a more expensive world. We are going to have inflated prices for a while.

But the good news is that with the base effect it won’t stay that for much longer. We’re probably nearing sort of peak inflation around the world with the numbers you saw out of Europe today, and what we are seeing in South Africa. So at some point it will subside. High inflation doesn’t last forever. Sarb, the Reserve Bank, is very prudent. I think it has its hands on things.

FIFI PETERS: All right. My fingers are crossed there, Nick. Thanks so much for those insights. Nick Kunze is a portfolio manager at Sanlam Private Wealth.

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