Asked in 1919 whether it was true that only three people understood Albert Einstein’s theory of relativity, physicist Arthur Eddington replied: “I am trying to think who the third person is.”
The latest Opec+ decision seems almost as complicated. Analysts scratch their heads: is it good or bad for prices, short and long term, and what does it say about the oil exporters’ calculus?
First, the axioms of the deal. Current cuts, both the mandatory and voluntary ones, will be continued until the end of September. Then the 2.2 million barrels per day of “voluntary” cuts, made by a group of eight Opec+ members including Saudi Arabia, the UAE and Russia, will be phased out at 200,000 bpd each month from October – that is, they should be completely removed by the end of August 2025.
However, the bigger group of 3.65 million bpd of cuts made by the entire Opec+ group (excluding three exempt members – Iran, Libya and Venezuela) will be retained until the end of 2025.
A chunk of this includes phantom cuts by countries that could not produce up to their assigned targets. Conversely, the UAE’s required production will be increased by 300,000 bpd, phased in gradually over the first nine months of next year, in recognition of its significantly increased capacity.
The alliance also retains the option to pause or reverse the lifting of cuts, depending on market conditions – though the UAE’s boost is firm. A planned reassessment by independent consultants of each country’s production capacity will be postponed until November 2025 for input into the 2026 policy. The UAE and Iraq in particular will be looking for official confirmation of their higher capacities.
Oil prices dropped more than $3 per barrel on the news, possibly exaggerated by algorithmic and momentum traders, but then made up some of the lost ground on Thursday.
Goldman Sachs declared the decision was bearish, citing the plan to phase out the voluntary production cuts, and lowered their price estimate to $75-$90 per barrel, with risks to the downside.
Hedge funds have their least bullish position in about a decade.
JP Morgan, though, saw the move as bullish in the longer term, signalling stronger demand, even if it led to short-term weakness.
So, in the words of Austin Powers: “What does it all mean, Basil?”
Some commentators remarked on continuing price volatility, and Saudi Arabia’s energy minister, Prince Abdulaziz bin Salman, discussed continuing economic uncertainties with only pockets of strong demand.
Uncertainties are always there, of course, but what is remarkable is how non-volatile prices have been in the last year and a half. They gyrated wildly from $68 per barrel just before the Covid pandemic, $21 in the worst period of the restrictions, to $139 in March 2022 after Russia’s invasion of Ukraine.
However, since late 2022, prices have oscillated moderately about $85 per barrel, basically the long-term inflation-corrected average, almost never breaking $10 per barrel higher or lower.
Part of this relative stability is explained by Opec+’s tuning of its cuts. And the latest decision should remove another potential source of volatility.
It limits the likelihood of a steep rise in prices if economic conditions improve, since then Opec+ will follow its trajectory of returning barrels to the market.
And on the downside, it eliminates for now the possibility of further defections from Opec, like Angola’s departure in December, or a breakdown of the production cuts system.
Serial over-producers, such as Russia, Iraq and Kazakhstan, have space to get back on target, even if they don’t compensate for past excesses. But they are also on notice that Riyadh will not shoulder the burden of extra production cuts solo.
Market balances suggest a significant deficit in the fourth quarter, even with the return of some Opec+ production – a limited amount, on the published schedule.
Opec’s own estimates for demand growth this year look too optimistic, given quite weak Asian import data. But its official projections don’t seem to have weighed heavily in this decision, and other agencies’ estimates also point to a drawdown of inventories.
While demand growth next year may not be strong enough to accommodate all the planned Opec+ increases, it seems unlikely the US will repeat its stellar production performance of this year in the face of lower prices. American crude and condensate output has not risen overall since October. While some projects in the Gulf of Mexico are due to start, production and exports could also be interrupted by an expected unusually strong hurricane season.
This decision accepts some short-term price weakness, for a more sustainable longer-term picture for Opec+. It marks a cautious reversal of the sequence of cuts; it turns from a strategy of price defence to one of regaining market share, as I have advocated for some time. That should allow a little more demand growth in emerging economies while deterring some high-cost competing production.
Analysts who point to the oil price Saudi Arabia “needs” to balance its budget should recall that it is revenue that matters – and revenue is price multiplied by volume.
So, we can cut through all the complexity of which cuts are being relaxed when, and by whom, and focus on the essentials. The Opec+ decision means mildly lower prices for now, but likely higher prices over the longer term as the group regains some market share. It is very cautious and qualified and open to being paused if market conditions aren’t as favourable as anticipated. It should limit volatility both on the upside and downside.
Opec+ has helpfully provided a chart of projected monthly production allowances for each member. But even without that, we don’t need advanced mathematics to identify this inflection point in the group’s market management.
Robin M. Mills is chief executive of Qamar Energy, and author of The Myth of the Oil Crisis
