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6 January 2022

OPEC unable to cut oil prices, despite production increase

The Organization of the Petroleum Exporting Countries and its allies – more commonly known as the OPEC+ group – have yet again failed to satisfy the global calls to suppress rising oil prices. While the price of oil is becoming increasingly separated from Covid-19 trends across the world, broader issues from the cartel’s poorer members are threatening its ability to keep oil in the thinning goldilocks (just right) region of profitable yet commercially acceptable.

Following its monthly meeting on Tuesday, OPEC+ agreed to extend its output target for February by 400,000 barrels per day. This extends the same rate of supply easing it has implemented since August, as it slowly brings back the oil from the 10 million barrel per day cut initiated at the start of the pandemic in April 2020.

Despite its initial position that no more of its oil is needed, OPEC+ has relented to pressure – largely from the US, India, and Japan – to curb inflation. JP Morgan now predicts that OPEC will be producing its pre-pandemic levels of oil by September; currently it still remains 2.96 million barrels per day short.

Oil supply has not risen in line with demand through the global recovery from the pandemic. OPEC+ cuts, led by the Saudi-Russian agreement, have remained tough. US production is down 12% compared with record highs before the pandemic. Because of this, Brent crude prices have risen by over 50% over the past 12 months. High oil prices mean high gasoline prices at the pump, and higher prices for transport are knocked onto the price of goods across the economy. The same applies to oil-based heating.

Downward pressure to oil prices is also coming from a surge in US fuel inventories. Demand has dipped over the holiday season and as the Omicron variant has seen global Covid-19 cases reach record highs; the US alone recorded over 1 million new cases on Monday.

Because of this, stockpiles in the country rose by more than 10 million barrels this week, marking their largest weekly build since the start of the pandemic, as supplies continue to back up at refineries. This may, however, partially be caused by tax incentives for producers to reduce their own inventories before year-end.

But despite these factors, oil prices have continued their month-long rally, and are nearing the 8-year highs seen in November before the Omicron variant first appeared and knocked 10% of the price. Benchmark prices for Brent Crude have risen 8.4% over the past week to $82 per barrel. The West Texas Intermediate (WTI) is up 3.5% to $79 per barrel.

These rises also come in spite of the US Federal Reserve saying that policymakers will have to raise interest rates faster than anticipated to fight inflation. In an increasingly digital economy, this would normally raise consumers’ and manufacturers’ costs and reduce the amount of time and money people spend driving. High interest rates also help strengthen the dollar against other currencies, meaning that American oil companies can buy more oil on the dollar, passing the savings on to consumers.

The fact that oil prices have continued to rise is a result of two factors. Firstly, with data starting to highlight that Omicron may cause less severe illness than previous variants – and thus less likely to cause economic shutdown – the spread of Covid-19 is starting to lose its grip on the global oil market.

Concerns of a vast surplus in first quarter of this year are easing. The cartel currently sees supply outweighing demand by 800,000 barrels per day in January, and 1.3 million barrels per day in February. This is markedly less than the respective 2 million barrels per day and 3 million barrels per day it expected back in December when Omicron fears were at their peak.

Secondly – and potentially more importantly in the long term – OPEC+ may be starting to lose its own grip and may not be able to manage its own proposed increases in output. The group missed its production targets by 650,000 barrels per day in November – 2.1% of its overall production for the month.

Compliance to production cuts sat at a massive 122% for ten of OPEC’s members in November, up from 116% last month, and significantly higher than the 107% from non-OPEC members. Many members of the group are struggling to reach their quotas due to economic turmoil and underinvestment, which has failed to see production assets brought back online following the pandemic.

Angola, for example, saw exports hit a record low during the month according to tanker schedules. Libya, one of the countries exempt from OPEC supply curbs, saw the second largest fall due to pipeline maintenance, while Nigerian output has been regularly impacted by unplanned power outages.

These countries have a much higher breakeven price for oil, and will face extreme difficulties in ramping up production, and lack the resources to maintain their existing assets. While this will be partially offset, on a global scale, by the spare capacity of OPEC’s richer nations, this capacity will soon be stretched.

OPEC+ is facing a new surge in pressure to keep production levels low, and for climate policy to draw peak oil demand closer. The traditional line of thinking from the cartel is that demand will plateau in the next ten to twenty years, although the rapid adoption of EVs is moving this forward at an alarming rate for oil producing countries. OPEC’s 13 members all depend on oil sales as a main source of income.

The frictions seen this week are part of an increasing amount of evidence that peak oil demand will trigger a new rivalry between oil producers, who will be fighting for a larger share of the waning oil market. More wealthy nations, with weak decarbonization policy, will be able to maintain their oil infrastructure for longer if prices collapse, with price wars favoring larger countries like Russia and Saudi Arabia. With OPEC’s biggest players and their allies having more power, smaller producers, or those looking to reduce production levels like the US, will be left struggling.

The cartel will want to keep as much control as possible on the output of its member states to prevent this from happening. Increasing its share of the shrinking oil market will not be a long-term benefit for member countries if global oil demand is steadily declining.