Why Opec+ was right to agree to increase oil supply

The grouping has chosen to focus on sustaining economic recovery rather than looking too far down the road

An oil pump works in the moonlight Wednesday, Nov. 12, 2008, in the oilfields of Sakhir, Bahrain, in the Persian Gulf. Oil prices dropped below $57 a barrel Wednesday on fears of stagnating global growth. Oil prices have plunged more than 60 percent in four months despite two recent OPEC production cuts. (AP Photo/Hasan Jamali) *** Local Caption ***  XHJ101_Mideast_Bahrain_Oil_Prices.jpg

"The world needs more oil," eminent oil historian Daniel Yergin concluded in the wake of news on Sunday that the alliance of leading producers, Opec+, which includes Russia, Saudi Arabia and the UAE, had agreed to increase supply to the market.

The author of The New Map: Energy, Climate, and the Clash of Nations and vice chairman of IHS Markit said "the growing demand does have to be met".

"There would be a heavy price to be paid if prices get too high. A spike in oil prices would not be good for economic recovery, would contribute to embedding inflation, and would end up damaging the market for oil in the years ahead. And there would be unpredictable political consequences."

Which makes the new agreement between the UAE and other Opec+ members a "very reasonable and even obvious compromise", he said.

"It maintains an orderly return of shut-in oil to the world market. But it also does two critical things: it adjusts the allocations to reflect changes in capacity since 2018 in a predictable way, which was the goal of the UAE and, at the same time, responds to the fact that the world needs more oil."

Daniel Yergin

Dr Yergin said the post-Covid-19 economy is stronger than many had anticipated.

"And that means stronger demand for oil. World GDP is already higher than in 2019, and we expect world growth this year of near six per cent. At the same time, despite the vaccines, the pandemic risk still casts a long shadow in the form of the Delta variant, and that requires some caution, as does the uncertainty over the duration of the strong economic rebound."

The finance ministers and central bank chiefs of the world’s 20 biggest economies have, meanwhile, also expressed cautious optimism about the global economic recovery. They have also indicated that they are committed to avoiding further Covid-19-related lockdowns.

As the G20 members acknowledged during their meeting in Venice this month, we have optimistic signposts amid what is a fragile and uneven pick up. The risks include new coronavirus variants and unequal access to vaccines.

"We are very concerned about the Delta variant and other variants that could emerge and threaten recovery," US Treasury Secretary Janet Yellen said following the in-person meeting in Italy. "We are a connected global economy; what happens in any part of the world affects all other countries."

It is this same anxiety over how events will unfold that also coloured the discussions between the Opec+ group these past two weeks. Together they have, over the past few months, skillfully managed the balance between supply and demand amid the Covid-19 impact by collectively making deep cuts to production.

Quote
There would be a heavy price to be paid if prices get too high
Daniel Yergin

Their last meeting had been 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 was already complete agreement between them that – amid rising demand for crude, thanks to the improving economic picture – the market needs more oil and that they are prepared to pump more. But the main difference to iron out was the approach to managing the long-term path forward as that demand recovers. That appears to have been achieved now, with the announcement that from May next year, the reference baselines for the UAE, Saudi Arabia, Kuwait, Iraq and Russia would be increased.

This also paved the way for the wider deal on output curbs to remain in place beyond April and until the end of 2022. The rationale to extend the agreement beyond April was based on the uncertainty felt about the economic outlook. But this anxiety may not manifest.

Analysts at Bank of America, for example, paint a more bullish picture. They have said that “robust global oil demand recovery will outpace supply growth over the next 18 months”, pushing oil briefly to $100 per barrel. Prices are currently at about $71 per barrel. This year, Brent Crude – the global price benchmark for crude oils from the Atlantic basin – has averaged approximately $65 per barrel compared to $41 last year, when it tumbled in the wake of lockdowns.

The issue at hand is the possibility that the recovery in demand will continue to outpace the increase of Opec+ supplies to the market – and this may cause a price surge, which, combined with a rally in other commodities, will stoke inflation.

Consumers around the world may not directly feel this as they did 40 years ago, when Americans faced long queues at petrol stations during the oil shocks of the 1970s. However, there will be a knock-on effect for them from an increase in costs for the manufacturers of a wide variety of goods. The reality on the ground is that industry, especially in the US, is already buying up more oil and oil-related products. The recovery is very real and is gaining momentum. Increased costs related to higher oil prices could put a brake on that.

The 23-nation Opec+ has already provided millions more barrels per day to the market from May to July, and they will now give millions more until the gap between supply and demand is filled.

Any seeming hesitancy to do so without commitments to the longer-term agreement on production curbs – on the part of Saudi Arabia and Russia – was linked to ensuring that the Opec+ group is able to maintain market stability in case the risks to the outlook do materialise. They may also worry, for example, about the impact of an influx of Iranian oil – should a new nuclear deal with the US and other world powers be concluded, thereby presumably allowing Tehran to resume exports.

The other side of the coin is that a lack of supply to the market could trigger a backlash from major customers.

India, the third-biggest buyer, has warned that high oil prices were “adding significant inflationary pressure”. The prospect of oil rising to $85 per barrel, or $100 per barrel, could also result in a reaction from the US; for one, the Biden administration may seek to avoid any pain for consumers there, and secondly, it could trigger a resurgence of US production, which would upset the very stability that Opec+ is seeking.

Given that the group has now agreed to add supply and to reassess the situation in December, longer-term considerations will be better managed once the demand picture becomes far clearer and anxiety levels about the future are likely to be lower.

Like Opec+, the G20 is also focused on stability – financial, fiscal and of prices. They seem to share the same concerns about a fledgling global economic recovery. The G20 is not delaying any necessary action to sustain the recovery.

Opec+ is also of the same thinking.

Published: July 19th 2021, 2:00 PM
Mustafa Alrawi

Mustafa Alrawi

Mustafa is an assistant editor in chief at The National, and an accomplished journalist and broadcaster, with over 18-years' experience working in the UK, the UAE and the wider Middle East.