Snapshot

OPEC wrangling emphasises EM energy exporters’ predicament


The sharp sell-off in global oil prices over the past week may well reverse once investor sentiment improves. However, the agreement among OPEC+ countries to increase crude production volumes makes it less likely that energy costs will climb to much higher levels.

That will come as a relief to those emerging markets (EM) where energy inflation has spiked in recent months, fuelling the urgency to raise interest rates.

Read more: Which emerging markets will be the winners and losers from energy transition?

Earlier this month negotiations among OPEC+ members had broken down amid disagreement over production increases. The disharmony highlights the predicament faced by EM energy exporters.

Major energy producers need oil prices of around $60 per barrel to balance the public finances and avoid the need to borrow or tighten fiscal policy. But the long term decarbonisation of the global economy means that the race is on to extract as much oil as possible before demand begins to decline. More disagreements over production seem likely.

Why Brent crude has fallen back in the past week

The price of Brent crude has fallen sharply after the stalemate over oil production targets across the OPEC+ group of countries was broken over the weekend. After trading around a three-year high since mid-June, Brent crude has fallen by almost 10% to below $70 per barrel this week.

Of course, the general deterioration of sentiment in global markets is likely to have contributed to the decline oil prices. But the OPEC+ deal is also likely to have played a part. The International Energy Agency (IEA) had only recently warned that restricted supply could cause the price of crude to spike over the summer.

This latest agreement now means that an additional 400,000 barrels a day of crude are to be pumped each month from August, with output expected to return to normal towards the end of 2022.

Why the OPEC+ deal will be welcome in some emerging markets

The decline in oil prices will come as a relief to those EM where energy inflation has risen sharply in recent months. After all, energy inflation is only just showing signs of easing having spiked to about 15% year-on-year (y/y) on average. This has added to concerns about runaway price pressures that have forced several central banks to begin raising interest rates.

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There is still uncertainty about the longer term outlook for oil prices as the global economy continues to recover. But it is now less likely that crude will climb to the kind of levels that would keep energy inflation much higher for longer.

Indeed, a quick back-of-the-envelope calculation shows that, in the absence of another leg-up in crude prices to somewhere in the region of $90-$100 per barrel, energy inflation should fall sharply in the second half of the year.

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The long term predicament facing EM oil producers

The recent impasse within OPEC+ highlights the predicament that EM oil producers face.

In the short term, our rough estimates suggest that EM such as Saudi Arabia, Russia and the United Arab Emirates still need oil prices to be in the region of $50-60 per barrel to balance the fiscal accounts.

As such, while there is room to absorb some decline in oil prices as production volumes increase, countries will be wary of driving prices too low. Should prices fall too much, these countries could be forced to borrow to plug holes in the public finances, or face the unpopular task of cutting subsidies.

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However, as we discussed in a recent research paper, the race to decarbonise the global economy implies that demand for fossil fuels with fall markedly in years ahead as energy consumption re-orientates towards more sustainable sources.

In the short term, energy transition could paradoxically boost demand for fossil fuels to power the huge challenge of building the infrastructure. But the bigger picture is that the shift towards net-zero emissions of carbon dioxide implies that demand for fossil fuels will fall dramatically in the long term.

With many major producers sitting on several decades worth of oil reserves, there is a clear motivation to get on with extracting them before they become trapped in the ground. As such, more disagreements on production in the future would not be surprising.

The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.