The Opec+ alliance faced a tricky situation last Thursday: how to reconcile the conflicting signals of the physical and paper oil markets? Their decision to maintain the current production cuts was presented as a cautionary move. However, too much caution can be as perilous as being too bold.
The problem was the reality of a weak physical market compared with a strong paper one. West African crude cargoes are going unsold while Chinese buying has slowed as refineries undergo maintenance and tanks fill up.
Opec+ members have good insight into the physical market: they know what their customers are requesting for delivery in May or June.
Yet Brent crude futures, the main international benchmark, went from $51 a barrel when the year began to $62.70 before the Opec+ meeting and $69.36 after it. That is a remarkable testament to the exporters’ discipline, for prices to hit their highest level since last May.
The resolution to this apparent paradox is that the futures markets are looking ahead to the third quarter, when demand is expected to outstrip supply as vaccines bring relief to big economies, international travel resumes and people dash out to spend their stimulus cheques.
Adding more oil to the market now, before that extra consumption materialises, would have heightened the risk of bloated stocks again.
In battening down the hatches for now, Opec+ has chosen to run three risks.
The first is internal dissension. The idea of raising output by 500,000 barrels per day each month did not survive very long. The existing cuts were extended, with the exception of output increases of 65,000 bpd for Russia and 10,000 bpd for Kazakhstan. This was probably the price of keeping Moscow on side.
But it does mean that while it started level with Riyadh a year ago, its allocation will be up to 9.38 million bpd in April, versus Saudi Arabia’s 9.12 million bpd – even before counting the kingdom’s 1 million bpd extra cut. Saudi Arabia will maintain that at least until the end of April.
Even when it does begin increasing it from May, most of the extra oil will go to meet peak power-generation needs in summer, rather than exports.
Iraq, for long the least compliant party to the deal, bumped up daily exports by 3.2 per cent in February. Iran, which is not bound by quotas, has recently been finding ways around sanctions and boosting its crude sales. A renewed nuclear deal with Washington seems some way off as the two sides joust with diplomatic manoeuvres and missiles.
The second is non-Opec competition, specifically the US. Saudi Arabia’s energy minister Prince Abdulaziz bin Salman said at the concluding press conference that, "drill, baby, drill" was gone forever. He apparently expects that the debt loads of US shale producers, the consolidation and growing domination by large companies and their promise to return capital to shareholders, instead of pursuing production growth, will prevent yet another rapid expansion in US output.
This would probably be the fourth time that Opec has written off shale, after having done so in the early 2010s, late 2014 and early last year.
Some US executives agree. Occidental chief executive Vicki Hollub is a frequent visitor to the UAE, given her company’s extensive operations here.
Occidental is also a leading producer in the western part of Texas, boosted by its pricey takeover of US rival Anadarko in 2019.
Ms Hollub said that oil production in the US would not return to 13 million bpd while Pioneer Natural Resources chief Scott Sheffield declared that he see US production being "flattish this year at around 11 million bpd, with very little growth in the future”.
However, the American oil industry’s capacity for irrational exuberance should never be discounted, especially with another $1.9 trillion washing around the system after the latest Covid-19 relief bill. West Texas Intermediate prices above $66 a barrel will prove tempting to drillers. Outside the shale patch, the Opec+ ministers will hope that the move by European energy companies to turn their backs on petroleum was a premature one.
The third risk is that of overtightening in what is still a very fragile market. After falling by 8.8 million bpd last year, consumption may recover by 5.5 million bpd to 6 million bpd this year, a record expansion. If US production stays at about 2 million bpd below its peak, Opec+ will eventually need to bring back almost all its cuts.
Indian oil minister Dharmendra Pradhan complained before the meeting that prices were too high. But there is genuine substance to the fear that a sharp rise in prices threatens a recovery in demand. After such a traumatic year, it is a brave wager that people will go back to their habits of daily commuting in cars and jetting off on holiday and business, even while fuel prices soar. And that is not to mention the tremendous boost the pandemic has given to plans for green recovery and non-oil technology.
Opec+, particularly Riyadh, still has three cards to play. The first is its move to monthly meetings that allow for a much quicker and more flexible response.
The second is Saudi Arabia’s 1 million bpd voluntary cut, which can be relaxed at will when the kingdom registers more demand.
The third is that by being a little aggressive on relaxing cuts, Prince Abdulaziz can make good on his previous pledge to have speculators “ouching”, and cool off the premature Brent rally.
The group needs to be ready to act when, and preferably, before the tide turns. The next few months will fix the course of the oil market for two years or more. Opec+ has to be clear about both its destination and route.
Robin M. Mills is chief executive of Qamar Energy and author of The Myth of the Oil Crisis