Chances for the Recent “OPEC+” Agreement in Succeeding to Control Prices

Sherif Abou El-Fadl | 29 Dec 2020

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:

  • Circulating news about the availability of coronavirus vaccines, and the announcement by some countries of their plans to buy the vaccine and start administering it to citizens, which means loosening some of the restrictions imposed on economic activities, stimulating the movement of markets, trade and transport, and subsequently addressing the structural imbalance that affected oil demand since the beginning of the pandemic.
  • While lockdowns have increased in the West due to the resurgence of the coronavirus in the context of what has been described as a "second wave of the pandemic", the situation is different for (energy-intensive) Asian countries, given that demand for oil in those countries is on the rise. Bloomberg has indicated that China has economically recovered to a large extent, and that conditions are developing in the same direction in countries such as India, Japan and South Korea. According to the US agency, this is evidenced by the celebrations of the Festival of Lights in India, and the increase in travel and mobility in China during the Golden Week to visit relatives across the country.
  • The economic stimulus plans developed by the world's largest countries. At the European Union (EU) summit that was held on 10-11 December 2020, the so-called European Recovery Fund (ERF) was agreed upon. The ERF is worth 750 billion euros (nearly 900 billion dollars), of which 390 billion euros will be distributed in grants and 360 billion in loans. It is estimated that southern European countries such as Italy, Spain and Greece will benefit the most, as they are the most affected by the pandemic. For its part, the Japanese government has raised its forecast for economic growth for the next fiscal year, thanks to the recent stimulus package aimed at accelerating the recovery after the damage caused by the pandemic. The latest estimate that was issued by the Cabinet Office in mid-December 2020 showed that the economy is expected to grow by 4 percent in real terms, adjusted for prices, in the next fiscal year that begins in April 2021. In the US, Congress approved a coronavirus relief package worth 892 billion dollars. The bill provides for the direct payment of 600 dollars to most Americans and their children. It excludes those with annual incomes exceeding 100,000 dollars, as well as illegal immigrants.
  • According to many estimates, the demand for gasoline and diesel has recovered by nearly 90 percent compared to pre-epidemic levels, which indicates that demand for the oil sector may be characterised by inflexibility with respect to some types of fuels.

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:

  • The return of some countries to taking economic lockdown measures due to the widespread resurgence of the coronavirus epidemic, talk about a new strain of the virus in Britain, and the disruption of transport, trade and travel, after they had witnessed a relaxation in the third and fourth quarters of 2020. This would have a great impact on the demand for oil at least in the first quarter of 2021. Fitch Ratings believes that demand will remain weak at least until the second half of 2021 in the light of the rapid spread of the virus in its second wave, in addition to the fact that administration of the vaccine, especially for developing countries, will not be fast enough for markets to recover. The International Energy Agency (IEA) forecasts indicate that global demand for crude oil will reach nearly 97.1 million barrels per day in 2021, an estimated increase of 5.8 million barrels per day compared to 2020. Despite this improvement, demand appears to be less than the 2019 level of 100.1 million barrels per day.
  • Concerns related to the possible tendency by shale oil producers in the US to pump more oil into the market, which poses a challenge to any development in oil prices, regardless of the size of compliance with the reductions scheduled by OPEC and its allies, especially in the light of the current circumstances and weak oil demand.
  • Fear that some countries may give up their voluntary cuts under the April 2020 OPEC+ coalition agreement, such as Norway whose cuts amount to 300,000 barrels per day, Iraq which calls for an increase in supplies, and other countries that may threaten to break up the coalition if the demand for oil remains low, thus preventing an improvement in prices. This could drive towards the market share war that broke out with the outbreak of the pandemic in March 2020.
  • Some countries with a special position on the cuts approved by the OPEC+ coalition are trying to forcefully return to the oil markets, such as Libya where an agreement was reached between the two parties to the conflict to lift the restrictions imposed on oil production and export, and seek to return to the production level that preceded the outbreak of the crisis in 2011. In addition, Nigeria demands that OPEC reconsider setting its oil quotas for reasons related to its need to pump more oil to support the economy and build the infrastructure.
  • In addition to the above, oil markets are anticipating the position of the new US administration (the administration of President-elect Joe Biden) on the return to the nuclear agreement with Iran, which is supposed to entail easing the strict sanctions imposed on Iran’s oil sector and Iran’s flooding of the market with two million barrels of oil per day.

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.

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