The world’s oil producing nations have finally agreed upon a plan that will continue a controlled reopening of the global supply through to the end of 2022. Adjustments have been made to resolve complaints from the United Arab Emirates (UAE) that it was be disproportionately punished through the supply cuts that were enforced at the start of the Covid-19 pandemic. The tense negotiations surrounding the deal, however, are something that will only become more common as falling demand threatens to throw the OPEC cartel into crisis.
The deal was agreed by OPEC ministers on Sunday, in a bid to cool off the global prices for oil. Prices have climbed to their highest since October 2018 as economies – and oil demand – have recovered from the Covid-19 pandemic, while the majority of the supply cuts, set out in April 2020, remain in place. Having peaked at $77.16 per barrel at the start of July, the price of Brent Crude fell by $2 on Monday following the agreement, now sitting at $71.60 per barrel. The agreement hopes to prevent at-the-pump oil prices from reaching unacceptable levels, which would – in theory – accelerate the consumer transition towards electric vehicles at the expense of the oil market.
The 24-member OPEC+ group now has a plan in place to control – and gradually increase – the production allocations of its members through to the end of 2022; an extension from a previous deadline of April 2022. From May that year, the UAE will have a revised contribution to the cartel’s total output, following a spat with Saudi Arabia that threatened to derail the entire plan, and caused the cancellation of OPEC+’s meeting at the start of the month.
In April last year, as the pandemic took hold, oil prices tumbled and even turned negative for some member states. The risk of devastating economic turmoil resulted in OPEC+ announcing supply cuts that removed 10 million barrels of oil from the daily global supply, helping to reverse the collapsing prices.
As demand slowly recovers, OPEC+ has gradually upped its production capacity, and the production cut now sits at just 5.7 million barrels a day. Now that demand is outstripping production, prices have soared above pre-pandemic levels, rising 50% this year alone.
Within this week’s agreement, the cartel will continue to increase its supply on a monthly basis. Production from the group will rise at 400,000 barrels per day each month between August and December, slowly bringing 2 million barrels per day back to the global supply.
While both Saudi Arabia and the UAE – the two most powerful countries in the OPEC cartel – had been supportive of an immediate output boost, the plan was initially put on ice. This was due to the UAE objection to the baseline production levels from which its supply cuts and output quota was being calculated.
Under the existing supply cuts in July, the UAE was required to limit its production to 2.7 million barrels per day, meaning that its facilities were operating at just two-thirds capacity. This level was calculated based on old capacity levels, set in October 2018 when capacity was just 3.8 million barrels per day in the country.
However, over recent years – and indeed throughout the pandemic – the country has invested billions in increasing its production capacity. Production capacity has recently grown from 4 million barrels per day to 5 million under a diversification plan from the Abu Dhabi National Oil Company, with extra output for refineries and petrochemical plants in Ruwais.
As part of the new agreement, the UAE’s baseline production quota – from which the cuts are being calculated – will rise from 3.168 million barrels per day to 3.5 million barrels per day.
The UAE is reported to be “happy with the deal,” according to Energy Minister Suhail bin Mohammed al-Mozroui, although details of how the deal was reached were vague. This is especially interesting during a period of time where broader tensions are arising between Saudi Arabia and the UAE. Having historically been as thick as thieves in the OPEC cartel, the pair have recently clashed over the Yemen war, as well as relationships with Israel and Qatar. The UAE also feels that Saudi Arabia is also stepping on its toes as a business and tourist hub, having recently invested $147 million in an aviation hub to compete with those in Dubai and Abu Dhabi.
Saudi Arabia and Russia will both see their baselines rise to 11.5 million barrels per day, up from current levels of 11 million barrels per day. Iraq and Kuwait will see their baselines rise by 150,000 barrels per day each. It is currently unclear which countries will see a reduced baseline to account for this, although both Algeria and Nigeria could also see their quotas revised, according to Prince Abdulaziz, the Energy Minister of Saudi Arabia. Venezuela, plagued by economic degradation, could see its baseline reduced as it struggles to maintain its existing production levels.
The group has agreed to extend their overall pact until the end of 2022 to provide market certainty and flexibility should the global recovery from the pandemic be stalled due to the emergence of new virus variants. OPEC has stated, however, that it intends for the production cuts to be fully phased out by around September 2022. It will also need to be wary of the 1.5 million barrels per day that Iran could add to the global supply once western sanctions are lifted and a deal is reached over its nuclear program.
For OPEC+, the deal represents the best outcome possible from the Saudi-Emirati spat. The UAE had previously signaled that it may be better off with more distance from the Saudi-Russian duopoly beyond April 2022. Without an agreement, the default production cut of 5.7 million barrels per day would have remained unchanged, causing prices to soar. Withdrawal would allow the UAE to pump far more oil into the global economy, with the state’s low production costs potentially making this worthwhile even if it drove the oil price down.
Without any production cuts, and with the clock ticking on the number of days the oil industry has left, those that can pump out oil at relatively low prices will want to make the most of what they have. This is certainly how the UAE sees its future, relying on using more oil resources, more quickly to fund its transition to green energy. The price war that would have followed would have been devastating for less developed regions like Algeria, which are extremely dependent on oil for economic growth, but have break-even prices that are significantly higher.
In the near term, the fact that a deal has been reached will reassure the global oil markets. Goldman Sachs – famously bullish on oil – has even stated that it could add a modest upside to its summer forecast for Brent to reach $80 per barrel. The market is expected to remain in deficit for a few months to come.
However, oil demand has probably already peaked. As the long-term outlook for oil weakens, oil producing nations will be less willing to collaborate as they try to avoid the complete stranding of their oil assets before the market disappears entirely. While this week’s deal, rather than a complete abandonment of supply curbs, will increase OPEC’s power in stabilizing the oil markets, the UAE’s tantrum may well have opened Pandora’s Box as far as spats within the cartel are concerned.
The gyrations have also shown how the cartel now threatens to derail the stability of the global economic recovery, having had a direct impact on the inflation of worldwide fuel prices. OPEC could soon end up hitting the expiry date that many have expected since its expansion to OPEC+, signaling a weakening in the global political sphere. Relying on the age-old guarantees of rising oil demand, long price cycles, and US trade security, simply can’t cut it for much longer.