Ben Cahill
The Organization of the Petroleum Exporting Countries (OPEC) and allied producers agreed on December 3 to add 500,000 barrels per day (b/d) to the market beginning in January, with similar increments potentially to follow in the next two months. The OPEC-plus group will gradually taper its oil production cuts instead of adding 1.9 million (b/d) in January as planned. Starting next month, the group will meet monthly to assess market conditions and will adjust output accordingly. The deal should avoid swamping the oil market with new supplies while satisfying some producers who are losing patience with deep production cuts.
OPEC was forced to scramble even more than usual to find a compromise. On November 30, the core OPEC group pushed back the second stage of talks by two days due to internal divisions over how to cope with significant demand uncertainty and address chronic overproduction by a few countries.
Following a short-lived but brutal price war, OPEC-plus cut oil production in April by 9.7 million b/d. It narrowed the cut to 7.7 million b/d in August and was slated to move to “phase 3” cuts of 5.8 million b/d in January 2021. Saudi Arabia was wary of adding nearly 2 million b/d into a weak demand market, and proposed extending the current cuts for three months, but agreed to the incremental supply increases to win consensus within the group.
The producers’ club will hope that the recent bounce in the oil market will carry over to next year. Until the past few weeks, many forecasters had continually downgraded their demand estimates for 2021 (see chart), including OPEC. But positive news on potential Covid-19 vaccines has boosted oil market sentiment, and the front end of the futures curve has tightened (Brent crude prices rose to nearly $50 per barrel following the deal). OPEC is optimistic that the oil demand picture will improve dramatically by the end of 2021.
Still, OPEC is wary of moving too quickly. Demand looks fairly soft in the coming months, especially in the Americas and in Europe, where new lockdowns and restrictions are curbing demand for transportation fuels. On the supply side, output in Libya has roared back from under 100,000 b/d in September to more than 1 million b/d, following the reopening of export terminals. OPEC also worries that Iran could add significant volumes later in 2021 if a deal is struck that would soften U.S. sanctions. Last, oil inventories pose a longer-term challenge. The demand crash earlier this spring led to a rapid buildup of crude and product stocks globally. Stock draws have begun, with U.S. crude oil inventories falling by 10 percent since mid-June. But commercial crude stocks in the Organization for Economic Cooperation and Development (OECD) states are still well above the 2015-2019 range. High inventories tend to suppress prices, and OPEC wants to ensure continued stock draws.
Tensions Growing
The latest deal proved again that OPEC tends to pull together under duress and craft short-term solutions. But after years of deep production cuts, tensions within the group have grown in recent weeks. Iraq’s oil minister argued that a “one-size-fits-all” model for production targets should not apply, given the varying levels of financial stability and resources among the OPEC states. Several states complain that Russia—a critical player in OPEC-plus and the co-chair of its Joint Ministerial Monitoring Committee—has been given a free pass despite its poor compliance since 2017.
The most striking challenge this week came from the United Arab Emirates (UAE). Reporting suggested that the UAE—a stalwart OPEC member and close ally of Saudi Arabia—was unhappy with its position in the broader OPEC-plus group. The UAE’s production capacity has reached 4 million b/d, and the country hopes to raise capacity to 5 million b/d by 2030—but its current OPEC-plus production target is just 2.59 million b/d. Abu Dhabi argues that this quota (with an October 2018 production baseline) is outdated. It plans to invest $122 billion in the oil and gas sector between 2021 and 2025. It is unlikely that Abu Dhabi is making these massive investments simply to increase spare capacity—in contrast with Saudi Arabia, which is OPEC’s key swing producer and has a state-directed capacity mandate. Fears that the UAE will quit OPEC are overblown, but Abu Dhabi will push harder to raise production.
In the big picture, the OPEC-plus framework has been highly successful, especially in navigating this year’s Covid-19 shock. When OPEC fell into disarray in March, markets panicked and the oil price crashed, but since April, its largest-ever production cuts have placed a floor under prices and provided assurances to the market. Saudi energy minister Prince Abdulaziz bin Salman notes that production compliance for the entire OPEC-plus group since May has been nearly 100 percent. Viewed from one perspective, OPEC-plus simply needs to hold together for a few more quarters until the demand picture improves and prices rebound.
Yet three years into the OPEC-plus pact, countries are losing patience. Deep production cuts are failing to deliver the revenue that many countries need—and some believe that perpetual cuts are simply ceding market share to the United States and other countries. It is getting more difficult to keep all the countries in the OPEC-plus alliance on board, and there is less and less tolerance for free riders. For now, the producers have strong incentives to stick together. Over time, especially if prices continue to tick upward and compliance ebbs, some of the cracks may widen.
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