Oil prices closed yesterday at their highest level since May, above the $66/bbl threshold, as markets anticipated Trump and North Korea’s historic summit. This morning, prices are trading slightly lower, bobbing above and below the $66/bbl level. Crude prices are currently $66.02, a loss of just 8 cents.
Fuel prices were unable to keep up with crude’s rally yesterday, and both gasoline and diesel ended lower for the day. Those declines are continuing this morning. Diesel prices are trading at $2.1555, down 0.5 cents from yesterday’s close. Gasoline prices are at $2.0939, a loss of 1.1 cents.
Far from Fire & Fury
Markets are abuzz with news of the historic meeting between President Trump and North Korea Chairman Kim Jong Un today. Held in Singapore, the summit was the first ever meeting between a sitting U.S. president and North Korea. The two countries signed a statement committing both countries to denuclearization on the Korean Peninsula and reduced American security activities in the area; however, the statement was vague and left much room for future negotiations.
The meeting was a rare occurrence of stability and calm among a slew of provocative headlines elsewhere in the world. Why then, would markets rise leading up to the summit?
Unlike the Middle East, which is a major oil supply source, East Asia has relatively low oil output. When instability occurs in the Middle East, it threatens oil supplies, causing prices to rise. In East Asia, conflict tends to weakens economic activity (reducing demand) while not significantly impacting supplies. Thus, stability on the Korean Peninsula is more likely cause higher prices due to strengthened demand forecasts.
OPEC Infighting Breeds Uncertainty
While North Korea is a rare bit of calm, OPEC continues to create uncertainty in regards to future production. The U.S. asked OPEC to consider increasing output in response to Venezuelan and Iranian supply falling off the market, and Saudi Arabia and Russia have both been pushing for an increase. However, other OPEC members (especially Venezuela and Iran) have opposed an increase. Iraq has joined the opposition, stating that cuts have not yet generated the desired price levels.
Infighting among OPEC members is not necessarily meaningful. OPEC has a long history of members ignoring production agreements and pumping at whatever levels they see fit. Many expected that “cheating” to occur when OPEC first signed their most recent agreement, and were surprised when it held together. OPEC has no authority to force Saudi Arabia or Russia to maintain current output levels, so those two countries could unilaterally increase production to the protest of Venezuela, Iran, and Iraq.
Unfortunately for the Saudis and Russians, unilaterally increasing output would incentivize other OPEC producers (especially Iraq) to ramp up their production reactively – the end result being a new “flood the market” strategy akin to 2015-16. While consumers might love that approach, it is not in Saudi Arabia or Russia’s best interests, so they may be forced to build consensus among OPEC members before increasing their output. That said, Saudi Arabia and Russia took on the lion-share of the production cuts a year ago, so they have a lot of clout in shaping the agreement.
OPEC’s meeting is quickly approaching on June 22, just ten days away. Given the uncertainty around this event, expect prices to react strongly to any new headlines. If Saudi Arabia and Russia gain the upper hand, prices will fall; if Iraq and other countries band together against those two nations, prices could rise back to the $70/bbl level.