As OPEC meets for its 165th meeting on Wednesday, the group will need to raise its output in order to meet the rising call on its crude in Q3 14, created by a seasonal demand pick-up. Given the state of Libyan output, the onus will fall primarily on Saudi Arabia, which can pose upside risk to prices, if falling spare capacity coincides with further unplanned outages.
But, the extent of the upside in prices will be determined by demand. Weak margins and fast rising product stocks suggest the q/q upswing in runs in Q3 14 may be more muted than previously anticipated (we have revised our estimates down to 1.7 mb/d from 2.2 mb/d), which would blunt the upward momentum in crude prices.
Of course, many refineries, for reasons of national policy, are effectively insulated against weak margins, and so any fall in crude prices will be muted. The risk is, with lower seasonal supplies keeping a solid floor on prices, Q3 14 could also turn out to be a bit of a damp squib, on the proviso that some refineries reduce runs and geopolitical tensions do not ratchet higher.
But beyond OPEC's short-term headache of balancing the market, certain long term trends are brewing that also need its attention. The IEA last week highlighted the rising investment needed in the Middle East, to offset declines elsewhere and prevent a sharp rise in oil prices.
This is a total U-turn from the IEA's views of the past few years. We believe the change reflects a systematic underestimation of decline rates ex North America, with the global annual average decline rate likely creeping up towards 7-8%. But Middle Eastern oil investment is hardly guaranteed, suggesting oil prices may continue exceeding market expectations for a while.