OPEC+ Countries to Step-up Production — What Are the Possible Implications?
As the world continues to adapt to the ways of the pandemic, there are a lot of things that still haven’t made peace with the new normals.
Oil, a vital commodity of consumption, and an epicentric element of the global economy, has invariably been hit hard by the effects of the pandemic. Faced with multiple production cuts and historically low demand, oil prices have continued to dive, painting a grim picture for oil producing and exporting countries alike.
Recently, an agreement was reached between the Organisation of the Petroleum Exporting Countries (OPEC)+ countries to increase production by 500,000 barrels per day (bpd) starting January 2021 and possibly by equal amounts in the next few months.
Although the agreement is consequential to the world gradually recovering from the effects of the pandemic and citizens looking forward to a state of normalcy following promising news on vaccination efforts, it is way more complicated than it looks.
Bit of Context
The OPEC is a systemised syndicate of 13 prominent oil producing and exporting countries which have a big hand in determining global oil prices. Since 2016, Russia and a few other oil producing nations (Mexico, Kazakhstan etc.), have asked for a seat at the table and have been wilfully granted the same by the amalgamation of OPEC and non-OPEC entities to form the OPEC+.
Now, Russia has been exercising its significant geopolitical clout to have its say in the traditionally Saudi-dominated club. In March 2020, both the countries launched a controversial price-war in the global oil market. While Saudi wished to enforce counteracting measures to mitigate plunging demand by cutting back on production heavily, Russia refused to comply.
Effect: A 65% quarterly drop in oil prices.
Domino Effect: Oil prices (WTI) turned negative on April 20th 2020.
Reducing demand, plummeting prices, pandemic-caused economic slowdown and the inter-continental price war ultimately led to a global stock market crash in early March. Things got so bad that those holding oil futures decided to pay offload contracts for the oil because they knew they would be unable to store it.
The Historic Ceasefire in April
OPEC+ reached a deal to cut production by a record 9.7 million bpd (close to 10% of pre-pandemic demand) starting May that finally ended the price war.
The cuts were scaled to 7.7 million bpd in August. With economies gradually opening up and pandemic concerns still looming large at the time, the gradual scale back was justified.
What Led to the Price War?
Since 2014, OPEC has been in a war against US shale oil producers whose growing capitalisation in the global market was a concern for the rest. This led to a series of price cuts by OPEC to veer off the shale producers and protect its own market share.
Two years down the line, things cooled down a bit and OPEC was back to its old strategy of cutting back on production to support oil prices. However, these cuts, much to their chagrin, also ended up keeping the shale producers in business and led to their expansion.
Meanwhile, Russia had concerns that the production cuts at the expense of shale producers were hurting the non-OPEC producers as well. It seemed like the only workable strategy the OPEC+ has agreed to at this point was to keep cutting production and waiting out the shale producers from the market eventually.
The Pandemic Factor
The strategy was put to screws with the sudden outbreak of the pandemic. In the process of cutting back, the OPEC+ realised that not only do they have to deal with shale oil in the maret, but also with millions of barrels of their own oil that was flooding the markets even as demand dropped unexpectedly.
So now, instead of staving off shale producers, the OPEC and non-OPEC countries were trying to stave off each other from the market. This is chiefly why Russia refused to cut back production at the beginning of the year, in an effort to defend its own market share.
Implication of Increased Production
As economies start to open up and vaccine optimism picks up, hopes of a quick global economic recovery are riding high. The production hike is chiefly banking on these hopes that the pandemic may be nearing its end.
However, an increase in the order of 500,000 barrels per day is a drop in the ocean. It’s half a percent of the pre-pandemic global oil demand. This indicates a cautious approach by the OPEC+ parties, who are holding their caps too close to the oil nest, so to speak, amidst still ongoing uncertainty of events.
It has certainly lifted prices again (Brent trading at around $49). There is, however, a three-month observation period that the OPEC+ have in mind before they decide to retain existing targets or ramp up production further.
However, reports of Saudi’s oil minister offering to resign from an important position in the group has raised political speculation of whether the recent decision (arrived at after much difficulty in negotiation) was unanimous. It certainly looks like a compromise, but let’s hope it doesn’t end in a stalemate with another price-war in the future!
(Originally published December 7th 2020 in transfin.in)
