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Podcasts from Confluence Investment Management LLC, featuring the periodic Confluence of Ideas series, two bi-weekly series: the Asset Allocation Bi-Weekly and the Bi-Weekly Geopolitical Report (new episodes posted on alternating Mondays), and a new monthly Q&A format called the Confluence Mailbag.
Welcome to the Confluence Investment Management Asset Allocation Biweekly Report. I'm Phil Adler. It may have taken a back seat among recent news headlines, but there has been a big shakeup within OPEC. Confluence advisory director Bill O'Grady joins us today to discuss what this may mean for investors. Bill, The United Arab Emirates has pulled out of OPEC.
Phil Adler:Now other countries have exited the price setting group in the past, but this may be a much bigger deal. Why?
Bill O'Grady:Well, the countries that have exited in the past were much smaller producers or actually in the case of Indonesia had become net oil importers. But even more importantly, The United Arab Emirates is is holding production was holding production off the market, and that amount represented 25% of OPEC's unused productive capacity.
Phil Adler:What led to The UAE's decision?
Bill O'Grady:The UAE has been aggressively boosting its productive capacity in part because it believes that oil will become less important in the future and thus wants to exploit its oil resources in the short term. The Saudis disagree with this position and thus want to manage price to exploit its oil resources over time. This modestly higher prices, but not so high as to encourage demand destruction. Destruction. Essentially, the Saudis are trying to maximize revenue over the long run by moderating the price.
Bill O'Grady:The Emirates wants to sell as much as they can now to pay to diversify its economy.
Phil Adler:I was curious. Do you think there's anything significant about the timing of this decision with the price of oil currently high because of the war in Iran and with the price setting powers of OPEC currently diminished because of the supply bottleneck?
Bill O'Grady:Well, I think that's a really important factor. By announcing this now, the market impact will be modest. It's even possible that The UAE and the Saudi Arabia can come to some sort of tacit understanding where The UAE doesn't always maximize output. Mexico at times, for example, has cooperated with OPEC without being a member. UAE could develop a similar relationship.
Bill O'Grady:If this announcement had occurred under normal circumstances, the impact on prices would have been bearish and swift, and it would have made potential future negotiations difficult.
Phil Adler:How much more oil could The UAE potentially put on the market once the war in Iran is over?
Bill O'Grady:Well, I estimate it'd be about 2,000,000 barrels a day.
Phil Adler:Bill, OPEC already has a somewhat spotty record of controlling supplies and prices in the past. Why has dominant control sometimes been hard to achieve?
Bill O'Grady:Well, it's a cartel with a lot of members spread across the world making cooperation difficult. Successful cartels need few members and some sort of enforcement mechanism. The only real enforcement mechanism OPEC has is that the Saudis, who hold the majority of excess capacity, will occasionally flood the market with oil to force down prices and discipline members. They did this successfully in 1985 and 1999, much less successfully in 2014.
Phil Adler:And with the abandonment of the group by The UAE, are OPEC's and Saudi Arabia's days as a price and supply regulator essentially over?
Bill O'Grady:Well, not necessarily, but it will make management of the cartel more difficult. I expect the Saudis to try, least for a while, to restrain production more than it otherwise would to try and maintain desired prices. But at some point, they'll tire of this effort, and they'll punish The UAE and other oil producers via lower oil prices if The UAE does, as we expect, boost production to its full capacity.
Phil Adler:Production facilities in The Middle East have suffered damage in this war. Is the damage enough to keep supplies tight and delay a major decrease in oil prices for at least a year or two after the war is over?
Bill O'Grady:Well, we don't know for sure, but probably yes. Middle Eastern oil fields have proven to be resilient in the past, but just getting tanker flows and patterns back to prewar levels will take at least three months and probably six.
Phil Adler:Looking out a little bit into the future, do you oil prices will eventually drop sharply at some point after the war is over and The UAE's withdrawal from OPEC is fully reflected in world markets?
Bill O'Grady:Well, I expect so, but it could take a while. First off, The UAE may not boost production quickly so as to maintain higher prices. Second, the global loss of oil and uncertainty surrounding the Strait Of Hormuz in particular and the region overall in general will likely lead to inventory rebuilding both commercial and strategic. That demand will tend to support prices perhaps for a couple of years. At the same time, the success of China's all of the above to energy strategy will likely be copied elsewhere, meaning that oil demand may fade over time as EVs expand electricity production rises.
Phil Adler:I imagine any sharp drop in the price of oil at some point down the road might take the fizz out of inflation and create a more favorable scenario for declines in interest rates and a bullish stock market.
Bill O'Grady:It certainly could, although I wouldn't be getting bearish on oil anytime soon. Inventory restocking will take time. And once consumers live through a significant disruption, that tends to cause precautionary inventory purchases that will support prices at least for a while.
Phil Adler:UAE's withdrawal from OPEC may have geopolitical repercussions that probably deserve more attention, but I guess are better left for a later discussion. So I'll close with this How does Confluence value shares of oil producers in this environment?
Bill O'Grady:Well, in the hard asset space, it's not our favorite sector. We are much more comfortable with industrial metals at this point. We do like energy broadly, though, but that would be defined as uranium, coal, natural gas, and oil. The all of the above strategy for energy security is bullish for energy broadly, but not necessarily for the oil companies, at least compared to other energy providers.
Phil Adler:Thank you, Bill. The title of this week's report is The UAE's exit from OPEC, and you can find a link to the written report dated 06/01/2026 on the Confluence webpage, confluenceinvestment.com. Our discussion today is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.
Phil Adler:Our audio engineer is Dane Stole. I'm Phil Adler.