OPEC+ meets on June 1 and the outcome could help determine whether oil prices rebound from their recent sell-off to around four-year lows or fall even further. At their last meeting on May 3, the group reaffirmed its April decision to increase production by 411,000 barrels per day by June as the beginning of a process that could eventually add as much as 2.2 million barrels of oil per day to the market.
As we noted in March, irrespective of OPEC, crude oil faces numerous headwinds including the rapid adoption of more efficient automotive technologies ranging from EVs and hybrids to gasoline stop-start engines. There are also macroeconomic factors such as slower growth in top importer China, changing behaviors such as work from home and the increased popularity of online shopping. In April, concerns over rising protectionism and slower growth added to the list of downside pressures.
That said, the possibility of increased production remains a major risk factor for prices, as a quick glance at the 2014-16 period and the 2019 and 2020 periods showcased in Figure 1, or the 1985-86 period demonstrated in Figure 2. In all three cases, OPEC, or at least Saudi Arabia, opted to increase production, sending prices down by more than 60%.
Figure 1: Saudi production increases sent prices lower in 2014-16 and 2019-20
Figure 2: When Saudi increased production in 1986, prices fell by more than 60%
There are also plenty of upside risks for oil prices. Among them are the low levels of inventories that OPEC expressly mentioned in their May 3 communiqué. Mid-May U.S. crude oil inventories are well below levels at the same time in 2021, 2023 and 2024 levels (Figure 3).
Figure 3: Crude inventories are below 2021, 2023 and 2024 May levels
Gasoline inventories are near average levels compared to the past four years (Figure 4), however, ultra-low sulfur diesel inventories are slightly lower than in 2022 and 2023, and well below their 2021 and 2024 levels (Figure 5). The combination of crude and refined inventories is lower than at any recent year except 2022, when crude prices were two times their current levels.
Figure 4: Gasoline inventories are at rather average levels
Figure 5: Diesel inventories are at low levels in the U.S.
Figure 6: Combined crude and refined inventories are below any recent year except 2022
As such, if OPEC chooses not to increase production, one can imagine a scenario with substantial upside risk. That said, OPEC production is still well below capacity and any sustained increase in production could potentially send prices lower unless those increases were met by strong demand.
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Figure 7: OPEC has the potential to substantially increase production
Going into the June 1 meeting, CME’s WTI CVOL index, a comprehensive view of implied volatility across strike prices, is rather low by historical standards at 38% as of May 22 (Figure 8). Likewise, the skew on options is only slightly negative, suggesting that traders price a slightly greater risk of extreme downside price moves than extreme upside price moves (Figure 9).
Figure 8: Implied volatility on crude oil option is trading on the low side of recent ranges
Figure 9: Implied volatility skew is slightly negative for crude options
Meanwhile, the WTI futures curve has a historically unusual shape: in backwardation for the first six contract months and in contango thereafter. The backwardation of the first six contract months might indicate the tightness of current supply which traders might see as easing up later on (Figure 10). That said, it’s hard to reconcile the notion that current supply is tight – however much that is supported by the inventory numbers– with the recent decline in oil prices across the futures curve which suggests that global demand is soft as well.
Figure 10: The WTI futures curve still has an unusual shape
Bottom Line
- Upside risks to oil include tight inventories and the risk that OPEC might not expand production as such as some traders currently expect.
- Downside risks to crude oil prices remain the same: soft demand in China and elsewhere, the possibility of further OPEC+ production hikes and rapidly evolving automotive technology.
