After several days of talks between members, the Organization of the Petroleum Exporting Countries (OPEC) led by the Kingdom of Saudi Arabia (KSA), and its allies from outside OPEC led by Russia, in what is known as the OPEC+ coalition, agreed on 3 December 2020 to raise the crude supplies of the 23 countries participating in the coalition by half a million barrels per day starting from January 2021, instead of what was planned in the agreement reached by the coalition parties on 12 April 2020, namely to increase production by nearly two million barrels per day starting from the beginning of 2021, bringing the total size of the reduction in oil production to 7.5 million barrels per day, down from 7.7 million barrels per day, according to the agreement of April 2020.
While the move constituted a positive support for the oil markets, given that the days following the agreement witnessed an increase in the price of crude to reach more than fifty dollars a barrel, at an estimated increase of 2 percent, this optimism remained fraught with caution due to the market's fragility as a result of the blurry expectations about the future of the revival of economic activity, which has a major impact on global demand for oil, in addition to fears either of an increase in oil supply by countries excluded from the production cuts, such as Iran and Venezuela, due to sanctions, and Libya, due to the turmoil it is experiencing, or of increased production by shale oil producers in the US, in a way that would pose a challenge to price stability and make decisions of oil-exporting countries always dependent on market conditions and subject to continuous evaluations and reviews.
Dimensions of the agreement
The recent agreement, which was reached at the beginning of December 2020, is part of the attempts by the oil-exporting countries, whether from within or outside OPEC, to bring about market balance and control prices, in the light of the structural deficit that hit oil demand as a result of partial and total lockdowns of economies worldwide due to the outbreak of the coronavirus, and the disruption of air traffic, transport and trade, which pushed global demand levels to nearly 90 million barrels per day, down from the level of 100 million barrels per day in late 2019. Those attempts began with the agreement between OPEC and non-OPEC independent producers led by Russia on 12 April 2020, after the agreement on new cuts faltered on 6 March 2020 as a result of technical and political disagreements. Subsequently, major producers flooded the markets with crude in the context of what was known as the "market share" war, which led to a sharp deterioration in oil prices and the loss by Brent crude of more than a third of its value to reach a level below 30 dollars a barrel, which was reminiscent of the price deterioration scenario at the end of 2015, which led to the formation of the OPEC+ coalition to bring about market equilibrium and control prices.
An agreement was reached between the KSA and Russia, after the intervention of US President Donald Trump to settle the crisis between major oil producers, create a balance in the oil market and control prices that had reached low levels that threaten the promising shale oil industry in the US. This resulted in the April 2020 agreement between members of the OPEC+ coalition, which approved cuts in oil production by nearly 9.7 million barrels per day in May and June 2020, which is equivalent to nearly three times the level proposed on 6 March 2020, of 3.6 million barrels per day. Afterwards, with the improvement in global demand, OPEC+ would envisage gradually reducing production by nearly 2 million barrels to 7.7 million barrels per day until the end of 2020, and then to 5.8 million barrels per day from January 2021 to April 2022.
The recent agreement constitutes an amendment to what was agreed upon in April 2020 between members of the OPEC+ coalition. Instead of reducing production to the level of 5.8 million barrels per day, as was supposed in the April 2020 agreement, it was agreed to reduce production by 7.2 million barrels, down from 7.5 million barrels per day. This is explained by the developments on the ground in terms of the decline in demand levels and the loss by the economies of the capability of rapid recovery as a result of the continuing spread of the coronavirus and the experience by some countries of successive waves of the pandemic, limiting the optimism about the improvement in oil prices, which stabilised at the levels of 40-50 dollars per barrel.
The members of the OPEC+ coalition also agreed that the meeting of the group’s countries to decide the level of production be held monthly, and that the increase or decrease in production based on the developments witnessed by the market be in the range of 500 thousand barrels per day. Oil market analysts believe that this aims to: first: show more flexibility and quick response to developments, so that the biannual meeting of OPEC+ would not be awaited; and secondly, adopt a gradual approach to increasing and reducing production based on market developments.
The recent agreement constituted a compromise solution for its parties, as it was considered satisfactory to those wishing not to disturb the market balance and to maintain the improvement gained in prices, given that crude oil recovered more than 150 percent of its value when its current price, which is nearly 50 dollars a barrel, is compared to the level of nearly 20 dollars in April 2020. At the same time, the agreement constitutes a response to the desire of some members to increase production to preserve the market share, which is a concern for some oil producers, especially the big ones, in a manner that is parallel to the desire to improve prices, perhaps even more important. Subsequently, the group would carry out monthly reviews and decide whether to continue with the gradual increase in production or stop it, which is supposed to be determined according to the prevailing market conditions.
Catalysts and challenges facing the agreement
The recent agreement of the OPEC+ coalition will face a number of catalysts and challenges that constitute the factors governing the movement of oil markets and prices during the period ahead.
The catalysts that may drive in the direction of market equilibrium and price improvement include the following:
On the other hand, there are challenges that work in the opposite direction, pushing towards market stagnation and decline in prices, which causes a deficit in the budgets of countries dependent on oil exports, in addition to being a threat to the oil industry itself. The most prominent of those factors are the following:
Conclusion and expectations
In the light of the conflicting expectations regarding the direction of oil markets and prices during the period ahead as a result of the continuing uncertainty that is currently being experienced by the global economy, it can be said that the price trend is formed based on the data imposed by the actual situation, and based on the dominance of market activation or stagnation factors, or the balance between those factors.
According to probabilities, despite the increase in production in January 2021 by 500 thousand barrels per day, the markets can maintain their balance by absorbing the surplus supply and reducing the accumulation of crude stocks in the main consuming countries in a way that would support crude prices, which would allow a gradual increase in prices during 2021.
In general, the OPEC+ members are likely to comply with the terms of the new agreement and the planned cuts, without taking any steps that would flood the markets and lead to a drop in prices, in a repeat of previous cases in 2020 or earlier years. It would be in everybody’s interest to remain committed to a gradual increase in production to ensure a relative balance of prices and avoid oversupply. This would maintain prices within their relatively acceptable limits of 40 to 50 dollars per barrel until at least the end of the first quarter of 2021.
Samir Ramzi | 03 Jan 2021
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