After several days of negotiations and postponed meetings, OPEC+1 failed to reach an agreement to reduce the global crude oil deficit. The group has been supporting the crude market since a deal was struck in April 2020, and it currently has 5.8 million barrels per day (bpd) of production offline. The plan proposed at last week’s meeting was to reduce the global deficit by adding back 2 million bpd of production through December and extend the deal’s expiration from April 2022 to December 2022. The only dissenter was the United Arab Emirates, which refused to agree to the deal’s extension unless the baseline for its own cuts was raised to reflect recently added capacity. The demand to decouple the two parts of the deal was rejected by the de facto leader of OPEC+, Saudi Arabia, and Monday’s meeting was canceled. Talks continue and a deal could be reached at any time; however, there is no date set for its next official meeting.
We believe the absence of an agreement increases uncertainty for the crude market. While the group’s official fallback to keep current cuts in place is bullish for crude, the range of outcomes over the medium term is high. We believe this disagreement between two core members increases the probability that the deal is abandoned entirely, potentially sparking a new price war. This would be the most bearish scenario for crude prices as nations may look to maximize production. While not as extreme, we believe there is risk of another scenario whereby higher prices and a tight fundamental outlook entices some nations to cheat on the current agreement by producing over their current quotas.
The credit profiles of investment-grade oil and gas producers have benefited from the rapid increase in global crude prices that began in November 2020. With prices well above corporate breakevens, companies have generated significant free cash flow and are quickly restoring balance sheets to pre-downturn metrics. This improvement has driven the sector’s strong YTD performance. Going forward, we believe that the probability of outcomes for crude prices is greater and note that shareholders will likely be the primary beneficiaries of higher prices as most companies are on track to meet their leverage targets. Given this fundamental backdrop, we believe there is limited upside at current spread levels for investment-grade producers.