Oil’s recovery is too fast for its own good

By Julian Lee

The OPEC+ alliance of oil producers will face a big test of its cohesion in a few weeks’ time, when ministers meet to discuss the next step in their historic production deal aimed at rebalancing the world’s oil supply with recovering demand. Things have almost moved too quickly in their favor.

Recent increases in crude prices and the rapid drawing down of visible stockpiles will undoubtedly lead to calls for a more rapid raising of production targets than was envisaged in December. That may well reignite tensions between the co-leaders of the group, Saudi Arabia and Russia, with the potential for more brinkmanship that could undermine the price recovery.

The report card was very good when the producer group’s monitoring committee met last week to evaluate progress so far:

• Aggregate compliance with the deal since it came into effect in May is at an unprecedented 99%
• Brent crude prices are testing $60 a barrel, a level not seen in more than a year
• Commercial oil stockpiles in the developed nations of the OECD are coming down and the group now expects them to fall below their five-year (2015-2019) average by August — a key target for Saudi Arabia

Bloomberg

How could anything possibly go wrong, you ask? Well, despite these successes, Saudi Arabia still seems obsessed with making every member but one honor their commitments to the barrel. After all, more than half of the countries that signed up to the output-cutting deal have failed to meet their obligations in full. And as has so often happened in the past, the lion’s share of responsibility for meeting the group’s goals has rested on Saudi Arabia, which, by December, had cut 37 million barrels more than it had signed up for originally.

Bloomberg

This obsession with individual compliance has led to Nigeria’s oil minister being tasked with bringing other African producers — specifically the Republic of the Congo, Equatorial Guinea, Gabon and South Sudan — into “full conformity with their supply adjustments” complete with mechanisms to make up for past breaches.

It all feels over the top given the quantities at stake and the potential impact on the ground. For example, Equatorial Guinea would have to stop pumping altogether for about 15 days to compensate for its overproduction. For South Sudan, one of the world’s poorest countries, it would require two-and-a-half months with no production at all.

At the same time, Russia, the group’s single biggest over-producer, is under no pressure at all.

Despite OPEC+’s stellar record so far, the continued pressure on these small producers, while not only turning a blind eye to Russia but even letting it raise production, indicates just how fragile the producer group really is.

It could afford to see the four African members walk away from the deal. At 740,000 barrels a day, their combined production in December was just 8% of Russia’s 9.11 million barrels a day. Much more importantly, they are all producing at close to capacity, meaning they could add almost nothing more to supply going forward. Russia, on the other hand, could boost its production by 1.2 million barrels a day if it’s not kept in the agreement. And that’s where its power lies.

Early next month, OPEC+ oil ministers will meet to discuss production plans for April. Saudi Arabia will be adding back the 1 million barrels a day of its voluntary cuts for February and March and, if oil prices remain at, or rise above, current levels, Russia will once again push to raise targets.

The amendment agreed to in December allows for monthly changes in the collective target of up to 500,000 barrels a day until a total of 2 million barrels has been added back. The first such increase came into effect last month. Given that Russia and Kazakhstan received their shares of the next increase spread over February and March, any output increases for April should, by rights, exclude them. I can’t see that going down well in Moscow.

Russia is already dealing with record fuel prices and oil companies have been instructed to divert more of their crude to domestic refineries and away from more lucrative exports. Russia is not an OPEC member and it took a lot of wooing to get it to join the wider alliance. It clearly wants to avoid handing the fruits of OPEC+’s hard labor to others and is particularly concerned about stimulating the U.S. shale industry by allowing prices to rise too far.

Bloomberg

Moscow may well want to claw back market share relinquished through the supply cuts more quickly than is comfortable for Saudi Arabia and others. The rest of OPEC+ may have little alternative but to accede to its demands. They remember only too well what happened last time they failed to keep Russia on board — a production free-for-all that saw prices tumble below $20 a barrel. Nobody wants that.