Oil slips from OPEC+’s grasp – where will prices head from here?

Key takeaways

• Oil prices are falling despite geopolitical risks, production cuts and still-solid demand
• USD 60 per barrel seems the new lower threshold for Brent crude prices in case of a major demand reduction. USD 100 may be tested in a severe supply disruption, yet we would expect OPEC+ to step in to cover any shortfall
• We see prices trading in a USD 80-90 range in the first half of 2024, with the potential to dip in the opening months of the year given excess supply
• In the long-term, higher non-OPEC+ supply and declining demand through the climate transition will become bigger drivers of crude prices.

Oil prices have long reflected global growth expectations and shaped inflation trends. The Israel-Hamas and Russia-Ukraine conflicts now link their trajectory more closely with geopolitical risks. So what do the sharp falls in oil prices in recent weeks tell investors about the outlook for 2024?

Falling oil prices in recent weeks are at odds with geopolitical risks and still-solid demand. Prices have dipped even in the face of Israel’s renewed ground offensive in Gaza, and more oil production cuts announced by the Organization of the Petroleum Exporting Countries and its allies (OPEC+) on 30 November. Brent crude oil is now trading around USD 78 per barrel.

Why the 15% fall in oil prices since mid-October? The main driver is fresh concerns over demand, as economic indicators show global growth is slowing. In addition, OPEC+’s latest production cuts – partly in response to this anticipated weaker growth in oil demand – were lower and less long-lasting than the market had expected. They were also voluntary commitments from some countries, rather than binding, group-wide cuts, which suggested disagreement among members. Falling implied volatility of oil derivatives also suggests that investors see diminishing risks of an escalation in the Israel-Gaza conflict.

We expect global demand for oil to keep growing in 2024, albeit more slowly than in 2023. Demand should rise by around 1.5 million barrels per day (mbpd), driven predominantly by China and emerging markets, and helped by a likely soft landing in developed markets. We also expect OPEC+ to continue proactively managing production to support prices. Oil demand traditionally dips in January, and markets should register a small surplus in the first quarter of 2024, after a December deficit, before a tight balance returns later in the year. This supports our view of prices trading in a USD 80-90 range per barrel for most of 2024, with some weakness possible in the months ahead, before demand picks up.

Is a USD 100 barrel likely again?

Of course, prices could spike higher if supply were severely disrupted. Possible drivers include a conflict escalation in the Middle East affecting seaborne transportation in the Strait of Hormuz or Red Sea, or stricter sanctions on Russian, Iranian or Venezuelan output. These are low-probability scenarios in our view. They might easily put as much as 1 mbpd of supply at risk. Around one fifth of the world’s oil (roughly 21 mbpd) is transported through the Strait of Hormuz; Iran and Venezuela have exported additional barrels close to 1 mbpd to global markets with the easing of their relationship with the US. A 1 mbpd change to the oil supply and demand balance would cause a more than 20 USD per barrel rise in our price model and see oil prices break USD 100 per barrel. However, in our view, both the US and China want to avoid such a scenario, and from OPEC+’s perspective, a price spike would likely hasten the global move away from oil. With its approximate 4 mbpd of spare capacity, we think OPEC+ would likely step in to smooth any major supply disruption.

Conversely, how far could prices fall? USD 60 per barrel looks like the new threshold for three reasons. Firstly, oil producers would likely reduce output to support prices, as production costs have risen notably. In addition, the refilling of US strategic petroleum reserves and OPEC+’s determination to manage production would also provide support. Scenarios that might drag prices lower include – in our estimated order of probability – greater-than-expected oil supply from non-OPEC+ countries, a sharp growth slowdown in developed markets, more non-compliance by OPEC+ countries with agreed quotas, or a price war by Saudi Arabia to take back market share.

Is OPEC+ losing its grip?

Indeed, flouting of agreed quotas within the group and rising oil production elsewhere are both problematic for OPEC+. The group added its ‘+’ in 2016, when it signed an agreement with 10 non-members including Russia, who had by then become major oil producers. This increased its control over the market but made group-wide agreements harder amid increasingly divergent interests. Saudi Arabia wants to control production to support prices – we estimate around USD 85 a barrel is needed to balance its 2023 budget – partly to fund projects including a vast new city in the desert. Angola and Gabon’s focus is different; they want ongoing production to spur investment in their own oil industries. OPEC+’s November meeting saw heated debates over both the size of cuts and which members would be affected.