OPEC will meet again on 30 November for its bi-annual meeting. This time not in Vienna, but virtually. The following day, the OPEC members are joined by the non-OPEC oil producers – led by Russia – (joint OPEC+) to assess and possibly adjust their production cut agreement. Normally it was already quite a challenge to get the oil producers in line with each other, with a lot of bilateral discussions in between. But a virtual consultation requires even more preparation in order to have all the noses pointing in one direction. After all, there are quite a few factors that serve opposing interests and can cause counterproductive price movements.
Demand recovery takes longer than expected as covid-19 spreads
During the last meeting of OPEC’s Joint Ministerial Monitoring Committee (JMMC), it was indicated that the demand for oil is again under pressure now that the covid-19 virus is spreading more intensively. The International Energy Agency (IEA) expects average oil demand to reach 91.7 million barrels per day (mb/d) for 2020. For 2021, it expects an increase to an average of 97.2 mb/d. If measures to counter the virus take longer and become more robust, the recovery of oil demand will also take longer. For the time being, the signals are not very positive.
Supply is already increasing, and there is more to come.
By reacting actively with a severe production cut, OPEC+ has prevented the oil price from fluctuating between USD 20 and 30 any longer, as we have seen between mid-March and the end of April. And although last month compliance (the degree to which oil producers keep to their own agreements) was 102%, in the months before that it was sometimes considerably lower. In the OPEC+ production cut agreement it was agreed that production cuts should be further reduced from January 2021. The current production cut of 7.7 mb/d is to be phased out from that date to ‘only’ 5.8 mb/d until April 2022.
At the same time, Libya, an OPEC member but not party to the agreement, has increased oil production from just 80,000 barrels a day in August to around 800,000 barrels a day in early November. According to the national oil company, Libya could increase production to 1 mb/d by the end of this year. And, much more importantly for the oil market, given the peace negotiations between the government and rebellions, the ports will open again and oil exports will also increase sharply. This puts extra pressure on the already well-supplied market.
Joe Biden’s victory in the American presidential elections could also bring new developments. Think, for example, of the renewed US involvement in the nuclear agreement with Iran. The Iranian authorities will only accept this if the sanctions are lifted and if oil exports are allowed to increase again.
Catch-22 or hog cycle?
The question to be asked at the OPEC+ meeting is whether production should be increased – or better, the production cut should be reduced – at a time when demand for oil is under additional pressure and inventories are still significantly high. Market rumours have already been heard from both Russia and Saudi Arabia that the current situation (of -7.7 mb/d) should be extended by at least three months to prevent a new slide of the oil prices. Producing less means a higher oil price, but on balance not necessarily a higher net profit. Many OPEC+ countries are facing lower revenues and higher expenditures to 1) support the economy to absorb the impact of covid-19, and 2) invest in the energy transition to diversify the economy. It is therefore not surprising that there are oil producing countries that, because of their fiscal budget constraints, do not want to reduce oil production, but rather increase it.
This presents the OPEC+ coalition with a difficult dilemma. A lower demand for oil leads to a lower price. If production subsequently also increases, there will be even more pressure on that oil price. The purpose of OPEC+ is to create stability for the oil price, preferably at a level that is (well) above 50 dollars. But if the price is rising, production in the US will increase again as it would become economically viable again. This seems to put OPEC in a Catch-22 situation. In such a situation it is virtually impossible to achieve a desired outcome without conflicting factors influencing this outcome again. The game between supply and demand has always been part of the oil market and led to cycles of high or low prices, the ‘normal hog cycle’. Nevertheless, this time it looks more like a status quo, where a way out will take much longer. OPEC and its partners can therefore look forward to some passionate digital discussions in the coming weeks. Discussions that will not leave the price of oil untouched.
A Dutch version of this column has been published earlier on BeleggersBelangen.nl