Reasons Behind Oil Prices Decline

Oil prices are trading at four-month lows as the market continues to digest the surprise move by OPEC+ to restore production earlier than expected, catching traders and analysts off-guard.

Brent crude prices plunged 3.4 percent to just above $US78 a barrel overnight, while West Texas Intermediate dropped 3.6 percent to settle near $US74 a barrel – the lowest level for both benchmarks since February. The sell-off extended on Tuesday, dragging Brent below $US78 a barrel, and WTI under $US74 a barrel.

Unexpected Production Increase by OPEC+

The sharp declines followed a scheduled meeting of the Organisation of the Petroleum Exporting Countries and allies led by Russia on Sunday (Monday AEST), where a small group of producers, led by Saudi Arabia, agreed to start phasing out voluntary production cuts from October. The market had been expecting the cut would remain in place until the end of the year. The curbs will continue in full in the third quarter before gradually phasing out over the following 12 months.

Impact of Increased Supply on Prices

It means more than 500,000 barrels a day will return to the market by December, and 1.8 million barrels a day by June 2025, triggering concerns that increasing supply will push down prices, particularly if demand remains sluggish.

‘Mildly Bearish’ Market Outlook

ING forecasts the move will leave the physical oil market in a small surplus next year. While OPEC+ said its plan was subject to market conditions, Westpac said the deal was “mildly bearish” for crude given the unexpected increase in production. “With global inventory rising, fuel inventory surging and more supply coming onstream through the fourth quarter, it’s hard not to see a push-back into the $US75 to $US80 range that contained us for much of the first quarter this year,” said Westpac’s head of commodity and carbon strategy, Robert Rennie.

Divergent Demand Projections

Goldman Sachs said the move made it more difficult for OPEC+ to continue low levels of oil production if demand was softer than the cartel’s bullish expectations. Still, not everyone is so bearish. OPEC forecasts that demand will grow by 2.2 million barrels a day in 2024, well above Goldman’s projection of 1.5 million barrels a day. London-based Capital Economics said OPEC’s decision would push the crude market into a significant deficit in the third quarter, meaning oil supply will be more constrained than it expected.

Impact on Consumer Prices

The weaker oil prices are yet to hit the bowser, with the latest data from the NRMA showing the average regular unleaded petrol price is up 7.3¢ per litre from the bottom of the cycle, and is expected to hit 207¢ over the next week. This, alongside a pick-up in oil demand over the northern hemisphere summer, could send prices towards $US90 a barrel, Capital Economics predicted. It has increased its price forecast for the end of this year to $US80 a barrel, from $US75. UBS and RBC Capital Markets are also confident that OPEC+ will maintain control of the market.

Iron Ore Correction

The slump in oil coincided with a decline in iron ore to its lowest level in more than six weeks, as concerns about China’s property market continue to weigh on prices. Iron ore futures in Singapore dropped as much as 4.4 percent to $US110.40 a tonne on Monday, the lowest since April 17. Prices fell below $US110 a tonne on Tuesday extending a 10 percent slump from the three-month highs above $US120 a tonne reached just two weeks ago.

Chinese Market Influence

The latest decline is despite efforts from Chinese policymakers to stabilize sentiment in the property market – a huge consumer of the steel-making ingredient – through a package which included government purchases of unsold projects and undeveloped land being sold back to local governments. While ANZ believes the measures should support a rebound in construction activity from current lows, the bank said it would do little to stimulate new projects, which are the real drivers of steel and iron ore demand. “Recent property support measures in China failed to ignite much hope of stronger demand,” said ANZ’s senior commodity strategist Daniel Hynes. “Further [iron ore] price gains will likely be capped by persistent concerns over the state of the Chinese property market.”

Long-term Projections for Iron Ore Prices

Westpac stuck with its view that iron ore prices won’t move higher than $US120 a tonne given China’s property plans are just “a drop in the ocean.” Rising iron ore inventory at Chinese ports at a time when stocks would usually be falling adds to the argument for that cap. “It feels as if it’s just a matter of time before we start to see a more meaningful correction below $US110 and eventually $US100, brought on by rising supply out of Africa,” Mr. Rennie said.

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