OPEC+ has finally managed to reach a production cut agreement after several days of increased internal dissent. In its statement, the group reiterated a continued commitment to a stable market, the mutual interest of producing nations, the efficient, economic and secure supply to consumers, and a fair return on invested capital.
The production cut agreement that has been in place since April 12 2020 has been slightly adjusted. In light of the current oil market fundamentals and the outlook for 2021, the group has agreed to reconfirm the existing commitment under the DoC decision to gradually return 2 million bpd to the market. Members have decided to voluntarily adjust January production by 0.5 million bpd from 7.7 million bpd to 7.2 million bpd.
At the same time, OPEC+ will be holding monthly OPEC and non-OPEC ministerial meetings starting in January 2021 to assess market conditions and decide on further production adjustments for the following month, with further monthly adjustments being no larger than 0.5 million bpd.
The outcome of the OPEC+ meeting has been welcomed by the media and speculators as a sign of stability. Optimism about oil prices and a global economic recovery has grown, with a multitude of future oil price graphics spreading like wildfire on the internet. Oil markets are relieved that OPEC+ will continue to cooperate and the group maintains the ability to move markets. Still, some observers remain skeptical as the eventual cooperation by members of the group only came after days of dissent.
Continuing optimism about a possible oil market recovery in H1 2021 is largely based on the wishful thinking of OPEC leaders, such as Saudi Arabia, and an irrational view on the positive effects of COVID vaccines on the global economy. The economic effects of a global vaccination scheme, which will likely take 6-18 months due to logistics, financial restraints and political strategies, are going to be minimal in the short term. OECD markets are unlikely to recover in H1 2021, as the availability of the vaccine is going to be a major issue. At the same time, OPEC+ seems to misunderstand that OECD economies are on life-support, it is only financial support mechanisms that are keeping these countries afloat. In 2021 most of these financial injections or QE mechanisms will be put on ice, as debt levels are reaching disastrous levels. A major economic downturn should be expected, and such a downturn would have a direct effect on oil and gas demand.
At the same time, the market is still struggling with an extremely high oil storage level, which has only partially decreased due to high refinery runs.
When looking at the demand for petroleum products, however, there is an imminent threat of a storage build up.
As some analysts have rightly indicated, the current oil price increase has nothing to do with OPEC+ strategies and decision-making, but instead is based on the (mis-)perception of investors, traders and speculators that the COVID-19 vaccine will be hitting the market and driving a major recovery. This wishful thinking appears to have infiltrated OPEC leadership as well, with the cartel’s statements likely to turn into self-fulfilling prophecies of deceit and defeat.
Even more worrying is the fact that internal OPEC dissent is growing, as the organization aims to get to grips with the distress in the market. For several key powers inside or linked to OPEC, the media-success story is one-sided and does not reflect the facts on the ground. For almost all OPEC+ members, especially Saudi Arabia, the UAE, and Russia, the agreement has become a double-edged sword. Being the market stabilizer and swing producer has not brought the rewards that the group hoped for. Government budgets have been hit, the burden of cuts is not being equally divided, and multiple participants are increasingly unwilling to comply anymore. As a Chatham House report already indicated last week, dissent is growing as the desire for new revenue streams grows stronger. The current deal is neither strong enough to drive a market recovery, or broad enough to ensure unity within OPEC.
At the same time, the new additional volumes that have been agreed for January 2021 fail to take into account the resurgence of Libyan production. It also doesn’t include the possible negative effects of higher oil prices, which could lead to a spike in U.S. shale and other production. The exemption given by OPEC to some members and the freedom of non-OPEC members to produce only add more pressure to the deal. OPEC itself still doesn’t admit the threat of a re-emerging Iran, of strong Iraqi production, or of the potential lifting of sanctions by Joe Biden. The OPEC+ approach seems to be “if you don’t talk about it, it doesn’t exist”.
Vienna based analysts and the OPEC leadership need to readjust their focus. The internal dissent within OPEC is clear, Abu Dhabi is just a primus-inter-pares in this discussion, but it’s actions make it clear that relations between Saudi Arabia, Russia, and the UAE are eroding. Others will follow, as national stability and survival always trumps international compliance. With no real room for improvement, OPEC and oil markets should be bracing for a very difficult H1 2021. Oil price volatility will lead to disruption as the search for profit is the key short-term incentive for many OPEC members. The sooner Saudi Arabia and Russia come to terms with the reality of today’s oil markets the better. Abu Dhabi, on the other hand, must recognize that it is also playing with fire with its threats to leave the group. It seems OPEC members are trying to secure future market demand by forcing other producers to sit on stranded assets. Currently, however, the threat of a major oil glut is very high. Markets should realize that the recent deal is a diplomatic effort to present a “success story to the press” while in reality members have been given the opportunity to do what they see fit to do. The cartel will be happy with $50 per barrel, but there is only so long prices can stay this high with the current market conditions.