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The Organization of the Petroleum Exporting Countries (OPEC) and its allies, a group that produces 40% of the world’s crude, want to keep oil prices high and stable. They have certainly been stable lately, although not as high. Despite the recent death of the Iranian president and the escalation of the war in Gaza, prices of Brent crude, the global benchmark, have remained no more than $2 from $82 a barrel since early May.
THE DIFFICULTIES OF OPEC
Part of the reason OPEC fails to keep prices high is that its members fail to meet production targets. In March, the group’s leaders and Russia extended production cuts, promising a reduction of 2.2 million barrels per day (b/d), or 2% of global supply, through the end of June, beyond to the 3.7 million b/d cuts previously agreed to for 2024. However, the cartel is overproducing, so much so that its daily production in 2024 is little different from that of the last quarter of 2023. This will create tensions when Members will meet to decide their strategy at the OPEC ministerial meeting on June 2.
ALL THE TENSIONS ABOUT OIL
Cheap oil also reflects other factors. Tensions between Iran and Israel are cooling, which has reduced the risk premium that triggered price spikes in April. Inflation is falling too slowly for the U.S. Federal Reserve to cut interest rates soon, even as the country’s economy is slowing. Chinese growth remains tepid. And new supplies are arriving on the market from outside OPEC, particularly from America, which is pumping in record quantities.
But OPEC’s surprisingly strong production is also helping the situation. For most of the past two years, the alliance has produced less than its quotas allow. The situation changed in January, when the new cuts were implemented. The cartel and its partners have exceeded the target every month since then. In April the glut approached half a million b/d, a level never seen before three years ago. As a result, global oil inventories continued to accumulate, despite expectations to the contrary.
WHO VIOLATES THE COMMITMENTS
OPEC and its allies have two types of cuts in place: mandatory ones, which apply to all members through quotas, and voluntary ones, announced by a subset of large producers, including Saudi Arabia, Russia and the United Arab Emirates. The problem is that individual producers have incentives to cheat, selling above their quotas and exploiting the efforts of others to keep prices high, in order to increase their own revenue. Analysis by Jorge León of consultancy Rystad Energy shows that some countries are performing badly on a large scale. Last month, volunteer cutters produced 806,000 b/d more than their collective targets predicted.
The worst, Iraq and Kazakhstan, have consistently violated their commitments. Russia, which is increasingly less compliant, seems to like the effect of the cuts announcement but does not like to sell less, perhaps because it needs to finance its war effort. Some estimates suggest that even Saudi Arabia, the cartel’s de facto leader and traditional enforcer, has slightly overproduced. These countries must hope that producers like Azerbaijan, Nigeria and Sudan continue to pump below their targets, as they are doing now, due to fraud, underinvestment and war.
In the short term, the cartel may get some respite. Global oil demand is expected to strengthen in the next quarter. After maintenance this spring, many refineries will return to operation and seek more crude. Demand for petrol will also increase, with tourists traveling for holidays. Most analysts expect Saudi Arabia and its friends to keep their announced cuts unchanged for the rest of the year. This could add $10 to the price of oil, according to bank JPMorgan Chase.
But OPEC’s strategy will be put to the test even more in 2025, when additional supply from non-OPEC members is expected to hit the market. In May, Canada inaugurated a long-awaited $25 billion pipeline that will allow it to export much more oil, encouraging its energy companies to increase production. Argentine shales are increasing production. And a series of offshore drilling projects, which have long lead times and are largely price insensitive, will conclude in South America.
WHAT SAUDI ARABIA WILL DO
This will make it difficult for Saudi Arabia to maintain high production levels without flooding the market. In the meantime, the kingdom could gain some leeway by increasing production a bit, so it can cut it again next year without losing too much market share. The remaining period of 2024 offers just such an opportunity, says Macquarie Bank’s Walt Chancellor. It is therefore possible that Saudi Arabia will decide to reverse some of its cuts, prompting others to follow. A decision along these lines would please Joe Biden, whose chances of winning November’s presidential election depend partly on pump prices, and central bankers wary of stubborn inflation.
Such a decision, however, would do little to quell dissent within OPEC. Many members believe the quotas are unfair and do not reflect recent capacity increases. All current production cuts, mandatory or otherwise, will expire by 2025. On May 14, Kazakhstan opened the debate on quotas for next year by arguing that an increase should be granted (it has a mega-project nearing completion). When the last major review occurred, in 2023, there was enough acrimony to delay a meeting for several days and push Angola to leave the alliance.
This time the distrust is so high that the group has commissioned three Western companies to test the members’ production capabilities. Their findings will not arrive in time for the June 2 meeting, leaving oil watchers in the dark about the cartel’s intentions for next year. But one thing is clear: OPEC is unlikely to reach a compromise that pleases everyone, meaning the temptation for members to misbehave will only grow.
(Extract from the eprcommunication press review)
