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In the weeks leading up to the last OPEC + meeting, a kind of consensus emerged among oil market watchers regarding the course of action of the major oil producers within the group. With a production cut deal scheduled to begin tapering off in January, the pressure to extend existing cuts for a few more months in the face of the worst Covid-19 wave so far would be too great.
However, OPEC + members are also facing budgetary pressures and are eager to increase production. As a result, the group can start increasing production as early as next month.
Internal disagreement
Oil prices fell on the last day of November after the virtual OPEC + meeting turned out to be more contentious than expected. Most analysts expected OPEC + to easily roll over the 7.7 million barrels per day (Mb / d) cuts for another three months, rather than letting them drop to 5.7 Mb / d as soon as January, as dictated by the terms of the existing agreement. Saudi Arabia, the most powerful member of the group, had already voiced its desire for this result.
However, just a few days earlier, the signs of internal discord became more apparent. The UAE, typically following Saudi Arabia’s lead, had taken a more assertive tone, reportedly demanding greater compliance from the group if the cuts were extended, including compensating certain laggards for past overproduction. The problem was that countries like Iraq made it clear that budget pressure required more production, not less. Russia has also overproduced and refused to compensate with deeper cuts.
“The Saudis were really disappointed in the UAE.”
In the weeks leading up to the meeting, the United Arab Emirates also hinted that they might eventually leave OPEC, another sign of Abu Dhabi’s quest for some independence from Riyadh. “The Saudis were really disappointed in the United Arab Emirates,” an industry source told Reuters.
The move caused a delay in the meeting for several days, postponing a decision until Thursday, December 3. Disagreement can be narrowed down to those who want to start ramping up production in January (keeping to the existing schedule), and those who want to postpone planned increases.
Rather than simply pushing the planned production increase of roughly 2 Mb / d from January to April, OPEC + appears poised to split the difference. The news emerging from the December 3 meeting is that the group 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 in four months. . But they will also meet monthly to assess the state of the market, so the precise amounts and timing are subject to change. Meanwhile, the compensation mechanism – the need for laggards to cut further to make up for past overproduction – will run through March.
Agreement reached, risks arise
The apparent agreement maintains a semblance of cohesion between the nearly two dozen oil-producing countries and also preserves market stability, avoiding potential disaster. At the same time, risks abound.
On the one hand, the agreement establishes a kind of moving target. If production limits change every month, tracking compliance will be difficult. The application will be even more difficult.
Increasing production at a time of weak demand could spoil the price rally.
A second risk is that increased production at a time of weak demand could ruin the price rally. The second and third waves of the coronavirus in Europe and the United States, respectively, are once again affecting the demand for oil. “The major oil market balance models, and ours, imply that ministers should have aimed to do more, not less, than the three-month delay if inventories normalize within the next 18 months,” wrote Standard Chartered. on a note to clientele. Adding more supply to the market at a time of renewed economic constraints could tip the market in a bearish direction.
But the 0.5 Mb / d monthly reduction, rather than releasing 2 Mb / d to the market in one go, goes a long way towards reducing that risk. In fact, Libya has added around 1 Mb / d of closed oil production to the market in recent months, and oil prices barely moved. Incremental increases over several months may not be as significant. In fact, the initial market reaction was an increase in oil prices.
A third risk relates to the cohesion of the OPEC + group, which seems more fragile as the duration of the agreement progresses. That poses more risks down the road, while also raising questions about short-term compliance.
Countries are eager to increase production as their finances deteriorate.
Countries are eager to increase production as their finances deteriorate. “Strict implementation of the agreed cuts, as demanded by the United Arab Emirates, is unlikely to be achieved, undermining their effectiveness and confidence in the group,” Commerzbank wrote in a report. The investment bank noted that Russia has been overproducing for quite some time. “If even Russia, which along with Saudi Arabia is the main member of the alliance, is willing to fulfill its obligations, it can hardly be expected that the other members will.”
Maybe that’s a problem for another day. OPEC + appears to have done enough for the time being, preventing a breach of the deal and also doing enough to prevent oil prices from falling. Rather than 2 Mb / d hitting the market in January, they will ease increases over time in 0.5 Mb / d increments.
