In the weeks leading up to the latest OPEC+ meeting, something of a consensus emerged among oil market watchers regarding the course of action for major oil producers within the group. With a production cut deal scheduled to begin easing in January, the pressure to extend the existing cuts for a few more months in the face of the worst Covid-19 wave yet would be too great.
However, OPEC+ members are also facing budgetary pressure, and are itching to increase production. As a result, the group may begin stepping up output as soon as next month.
Oil prices fell on the last day in November after the OPEC+ meeting – held virtually – proved to be more contentious than expected. Most analysts expected OPEC+ to readily roll over the cuts of 7.7 million barrels per day (Mb/d) for another three months, rather than letting them unwind to 5.7 Mb/d as soon as January, as dictated by the terms of the existing arrangement. Saudi Arabia, the group’s most powerful member, had already signaled its desire for this outcome.
Just days prior, however, signs of internal discord became more evident. The UAE, typically following Saudi Arabia’s lead, had struck a more assertive tone, reportedly demanding more compliance from the group if the cuts were to be extended, including compensation from certain laggards for past overproduction. The problem was that countries such as Iraq made clear that budgetary pressure called for more production, not less. Russia, too, has overproduced, and has not been keen on compensating with deeper cuts.
“The Saudis were really disappointed with the UAE.”
In the weeks leading up to the meeting, the UAE also hinted that it might eventually leave OPEC, another sign of Abu Dhabi’s pursuit of some independence from Riyadh. “The Saudis were really disappointed with the UAE,” an industry source told Reuters.
The jockeying led to a delay in the meeting by several days, pushing a decision off until Thursday, December 3. The disagreement can be boiled down to those that want to begin increasing production in January (keeping the existing schedule), and those that want to postpone planned increases.
Instead of simply pushing off the planned increase of production of roughly 2 Mb/d from January until April, OPEC+ appears poised to split the difference. The news coming out of the meeting on December 3 is that the group has agreed to monthly increases of 500,000 barrels per day (b/d) in 2021, which will add up to a cumulative increase of 2 Mb/d, presumably over four months. But they will also meet monthly to assess the status of the market, so the precise amounts and timing are subject to change. Meanwhile, the compensation mechanism – the need for laggards to cut deeper in order to make up for past overproduction – will be extended until March.
Deal reached, risks emerge
The apparent agreement maintains some semblance of cohesion among the nearly two dozen oil-producing countries, and it also preserves market stability, heading off a potential disaster. At the same time, risks abound.
For one, the agreement sets up something of a moving target. If the production limits shift each month, monitoring compliance will prove tricky. Enforcement will be even more difficult.
Increasing production at a time of weak demand could spoil the price rally.
A second risk is that increasing production at a time of weak demand could spoil the price rally. The second and third waves of the coronavirus in Europe and the United States, respectively, are hitting oil demand once again. “The main oil market balance models, and our own, imply that ministers should have aimed to do more, not less, than the three-month delay if inventories are to normalise within the next 18 months,” Standard Chartered wrote in a note to clients. Adding more supply onto the market at a time of renewed economic restrictions could tip the market back into a bearish direction.
But the monthly tapering of 0.5 Mb/d – rather than throwing 2 Mb/d on the market all at once – goes a long way to reducing that risk. In fact, Libya has added around 1 Mb/d of shuttered oil production back onto the market in the last few months, and oil prices hardly moved. Incremental increases over several months may not matter all that much. In fact, the initial market reaction was a rise in oil prices.
A third risk relates to OPEC+’s group cohesion, which seems more fragile as the duration of the deal wears on. That sets up further risks down the road, while also raising questions about near-term compliance.
Countries are eager to ratchet up output as their finances deteriorate.
Countries are eager to ratchet up output as their finances deteriorate. “It is unlikely that the strict implementation of the agreed cuts – as demanded by the UAE – will be achieved, which will undermine their effectiveness and confidence in the group,” Commerzbank wrote in a report. The investment bank noted that Russia has been overproducing for quite a while. “If not even Russia, which alongside Saudi Arabia is the leading member of the alliance, is willing to meet its obligations, the other members can hardly be expected to do so.”
Perhaps that is a problem for another day. OPEC+ seems to have done enough for the time being, preventing a breakdown in agreement and also doing enough to keep oil prices from falling. Instead of 2 Mb/d hitting the market in January, they will ease in the increases over time in 0.5 Mb/d increments.