​The unexpected turn of events leaves consumers uncertain as to whether OPEC+ will turn on the taps in let more oil flow to the market and ease the current tight oil supply and rising prices. It also tarnishes the reputation of OPEC+ as central bank of crude oil.

Earlier on Thursday, OPEC and its allies appeared to have an agreement in principle to boost output by 400,000 barrels a day each month from August to December. It would also have extended the duration of the OPEC+ deal, setting the final expiry of the cuts in December 2022 instead of April.

That preliminary agreement was put on hold by the United Arab Emirates which said it will block the deal until the baseline for its own cuts is adjusted, effectively raising its production quota. This could open Pandora's box as other members could demand production increases which would ultimately flood the market with too much oil.

The UAE’s cuts are measured from a starting point in 2018, setting its maximum capacity at about 3.2 million barrels a day. Expansion projects have since raised that number and the country wants its baseline reset to about 3.8 million barrels a day. The UAE argues that the change is necessary because, under the current terms of the OPEC+ deal, it is making proportionally deeper cuts than other members. They say that this unfairness would persist for even longer if the accord is extended until the end of 2022.

Russia and Saudi Arabia, the leaders of the group, rejected the UAE’s request. Talks will resume on Friday, allowing time for consultations at higher levels of government. So right now, the market is in hurry up and wait mode.

The production index actually rose to 60.8 from 58.5, which was a surprise given the well publicised supply chain issues hitting the sector. However, the fact is the manufacturing sector is struggling to keep pace with the scale of demand. New orders continue to flood in as indicated by a 66.0 reading while the backlog of orders continues to surge, although at a slower pace than in May. This means supplier delivery times continue to lengthen with customers increasingly desperate for stock as indicated by another steep contraction in their inventories.

Labour Shortages

Employment actually fell into contraction territory (49.9) whcih was unexpaected given the strong demand. WHat this tells us is that manufacturers can’t find workers to fill vacancies. Consequently, in order to hire and retain employees, companies will probably have to increase their pay rates to attract candidates. Companies are already paying more for everything else with the prices paid component hitting its highest level since 1979. In the short term, labour is likely to add to those cost increases.

Labour shortages may become less of a constraint from September as childcare issues ease and expanded unemployment benefits come to an end, but there is no guarantee given evidence to suggest potentially more than 2 million people have taken early retirement in the past year. Consequently this could lead towards a longer period of elevated costs for employers as they attempt to find suitable employees.

Given the backlog of orders and customers getting frustrated with low inventory numbers, manufacturers increasingly know they have pricing power and can pass higher costs on. This all adds to the case for higher inflation that is likely to be more persistent than the majority at the Federal Reserve acknowledge with the case building for a 2022 first interest rate hike.

Residential Construction

Residential construction rose 0.2% while non-residential contracted 0.7%. This was the the 15th fall in the past 16 months – given the uncertainty over the need for office space and constraints on local government spending. Residential remains very strong though, with output up 28.2% year-on-year. It's a similar story to that of the manufacturing sector in that there are supply constraints, the cost of materials and the ongoing problem of finding workers. Consequently, there is a higher probability of seeing the rate of activity slow. With strong demand for new homes, house prices are likely to keep rising at double-digit annual rates through the rest of the year.

U.S. Oil Demand

The strength of the U.S. oil demand recovery is underpinned by these record rate drawdowns and this is just ahead of talks between OPEC and it's allies on Thursday to negotiate a potential output increase.

As the U.S. emerges from months of lockdowns, Americans are taking to the roads and skies in increasing numbers. Earlier this month, California, America’s most populous state, re-opened its economy, while New York ended most of its lockdown restrictions. To meet demand, oil refiners boosted crude processing to levels to pre-pandemic levels. 

Supply Outlook

The global supply situation looks set to remain tight as OPEC and its allies have yet to come to an agreement on how much shut-in oil to return to the market. That has delayed preliminary talks between ministers by a day to allow more time for a compromise before Thursday’s discussion. The International Energy Agency has warned of supply deficits in the second half of this year unless OPEC acts fast to add more crude. 

Crude oil stocks in Cushing, Oklahoma, the delivery point for WTI futures, are at the lowest levels in over a year. Indeed, some analysts are forecasting that these stock levels will drop to multi-year lows by the end of the summer.

At the same time U.S. drillers have been slow to respond to higher oil prices, which are up more than 50% so far this year. Domestic crude production is holding at roughly 15% below peak levels seen early last year. 

Spreads

Looking at the Nymex calendar spreads, we can see that the September West Texas Intermediate futures contract has increased to $1 a barrel premium over October for the second time this month. This suggests that the market is expecting ongoing supply tightness through the summer. Prior to this month, the spread between the second month and third month WTI contracts hadn’t exceeded $1 a barrel since 2018.

Overseas interest in American crude oil has also been climbing despite a bumpy recovery from the health crisis in Asia and Europe. Exports of U.S. crude remain strong even as rallies in WTI have narrowed its spread relative to the global benchmark Brent, to less than $2 a barrel.