The Opec+ agreement, concluded last April, has been a remarkable success in dragging oil prices out of the worst demand crisis. But it was always clear that the route back to normality would pose different challenges from the emergency measures. Monday’s meeting of the group was postponed as co-chairs Saudi Arabia and Russia took more time to consider the UAE’s proposed amendments to the baseline that production levels are set to. There is also disagreement over the long-term path forward as demand recovers amid the Covid-19 pandemic.
The deal has not failed, as some headlines say. The production cuts agreed in April, and gradually relaxed since then, remain in place. The members also concur that the market needs more oil, and had aligned on an increase of 400,000 barrels per day each month. Oil prices have risen almost linearly from under $40 per barrel in November to $77 on Tuesday, showing that demand has recovered strongly, and that, if anything, the proposed Opec+ increase was on the low end.
The sticking point relates to the end of the deal, currently set to expire next April. The group had been voting on a proposal to extend the co-operation until the end of next year, continuing with the regular monthly production increases. The UAE feels it is unnecessary to decide on such a prolongation now.
It maintains that any extension would also require baselines to be reconsidered, giving it higher permitted output. Based on April 2020, the last time members were producing without constraint, the UAE’s baseline is 18 per cent below maximum. Instead of its baseline of 3.168 million bpd, it is seeking 3.841 million bpd.
Saudi Arabia’s 11 million bpd is only 5 per cent below the April 2020 level; Russia, also set at 11 million bpd, is 5 per cent above April 2020. Several other adherents of the pact, such as Angola, Azerbaijan and Algeria, have recorded production declines and likely could not return to early 2020 output, even if they were allowed. I predicted in September that the passage of time, bringing increasing misalignment of production quotas with national capacities, meant problems by 2022.
Oil prices jumped on the news of the meeting’s postponement, with Brent crude rising above $77 a barrel, the market focusing on the lack of an immediate production increase. Agreement would need to be reached soon for the purpose of planning August’s output.
But the deal is finely balanced. If countries do not see a clear path forward, while prices are strong, the very high compliance achieved to date will weaken. Iraq has been the least-compliant and remains in desperate need of revenue. Russia has also tested the boundaries of the agreement. Production cuts could crumble slowly, or suddenly evaporate if Riyadh grows tired of subsidising others’ overproduction.
As Prussian General Carl von Clausewitz said, “The best strategy is always to be very strong, first generally, then at the decisive point”. The UAE’s position is strong, generally because its financial situation allows it to tolerate lower oil prices, and at the decisive point because it holds large and growing spare capacity. It is the only Opec+ member with substantial growth in output capability over the past two years and credible plans to go further.
Sanctions on Iran, a lack of investment in Kuwait and shambles in Venezuela have made the UAE decisively Opec’s third-largest producer, not far behind Iraq.
This is entirely in line with the plans of Adnoc, the UAE’s main oil-producing company, to reach 5 million bpd production capacity by 2030. Similar to the situation in Iraq, a host of international partners who have joined its fields since 2014 want to see a return on their investment, not continuing deep production curbs.
US shale has slumbered since the pandemic, as shareholders demand cost discipline and cash returns. But a lengthy period above $80 a barrel will again awaken the Kraken, a lesson Opec could have learnt in 2009 or 2016. Russia is well aware of this threat.
And with the prospect of a decline in long-term oil demand as electric vehicles and other technology advance, it makes no sense for the major low-cost producers to limit their output severely while others gain market share.
How will this situation be resolved? There could be agreement to defer consideration of the deal extension and baselines until later in the year, when the market situation may look different. This could risk volatility as the deadline grows closer.
Immediate production increases could go ahead while the Opec+ committees take their time to reassess the baselines, but this is inherently a political rather than technical decision. Changing quotas brings winners and losers and is always hard for Opec to achieve, unless market realities have become inescapable or a period of breakdown allows for a reset. It would be wise to find some flexibility or exiting the deal elegantly will prove much harder than it was entering into it.
Robin Mills is chief executive of Qamar Energy and author of The Myth of the Oil Crisis