Omicron-driven oil slump raises risk of OPEC+ action

So far today, the market is trading higher, but already off their overnight highs, but the reduction in hedge selling has allowed buyers to take a fresh look with some concluding the move on Friday was most likely an overreaction. Not least considering the prospect for support being provided by OPEC+ who may attempt to prop up prices when they meet this Thursday. The group may decide to postpone the January production increase or if necessary, temporary cut production into a period that was already expected to see the return of a balanced market.

Brent crude oil’s 11.6% top to bottom slump on Friday was only arrested when the price reached its 200-day moving average at $72.70 and after the price retraced 61.8% of the August to October surge. A key reason behind that run up in prices was driven by increased switching demand from record priced gas to cheaper oil-based fuels such as diesel, heating oil and propane. Following the drop in crude oil and continued strength in gas and power prices, the prospect for continued and rising switching activity will remain a key source of extra demand that did not exist during the 2020 slump.

Ahead of Thursday’s OPEC+ meeting the group has postponed their technical meeting, giving themselves more time to assess the impact of the new coronavirus variant on oil demand and prices. It comes at a time where the market in general is grappling with what to do about the omicron covid variant. The worst impact so far is from the speed with which countries are moving to halt inbound foreign travel, with many countries stopping all flights from South Africa and other countries in the region, while Japan has taken the dramatic step of halting all inbound foreign travel from tomorrow. More hopeful indications from virologists in the virus origin area are anecdotally that this variant is not particularly virulent, although others point out that too little is known about the virus’ effects on more vulnerable patients. 

Goldman Sachs and Morgan Stanley have both in their latest updates calculated that based on no response from OPEC+, the market after Friday’s slump is now pricing in a 4 million barrels/day negative demand hit over the next three months. The impact during last winter’s second wave was around 2 million barrels per day. IF OPEC’s technical committee draws the same conclusion, the market could be in for a surprise production cut on Thursday.

The risk of 90-dollar oil has not gone away, but once again the timing has been postponed with 2022 increasingly looking like a relatively balanced year. The main worry remains 2023 and beyond when OPEC+ have exhausted their ability to increase production. Not least considering a potential decade of underinvestment's with oil majors losing their appetite for big projects, partly due to an uncertain long-term outlook for oil demand, but also increasingly due to lending restrictions being put on banks and investors owing to a focus on ESG and the green transformation.