CAREFUL COMPROMISE

The plots around the revision of the terms of the OPEC+ deal to cut oil production in 2021 received an unexpected outcome. Although the parties initially agreed to increase production by 2 million barrels per day (bpd) from January 2021, the current situation on the oil market clearly does not support such a risky step. On the contrary, it was highly expected that the current restrictions on oil production (7.7 mbd) will be extended, at least for the first quarter of the coming year. However, the oilmen could surprise both the market and the experts once again, risking to agree to soften the conditions to some extent, or rather, to increase production by 500 tbd.

Good decision

The total decrease in the OPEC+ production in January 2021 will reach 7.2 mbd from the baseline level instead of the previously discussed 5.8 mbd.

The new terms apply only to the first month of 2021; further adjustments to the restrictions will be discussed during the ministerial meetings of the signatory countries scheduled to be held monthly starting in January.

The decision was not easy at all, especially since the positions of the leaders of the deal - Russia and Saudi Arabia - were very different again. The current outcome looks more like a forced compromise between the OPEC and non-OPEC member states in order to avoid the collapse of the previous agreements, as it was in March 2020. Nevertheless, such a cautious approach is fully justified - although the oil market is stable, it is still fragile, and this compromise will make it possible to continue balancing and preventing the prices from collapse.

Russian Deputy Prime Minister Alexander Novak summed up the results of the OPEC+ ministerial meeting on December 3 and said that increasing production by 2 mbd in winter would not be safe for the market, and a smooth exit from restrictions "is a good decision."

“Unfortunately, the second wave of COVID-19 is the uncertainty that has a negative impact on the market today. The demand has not fully recovered. Today, there is still a deficit of some 9 mbd in demand compared to the period before the crisis,” Mr. Novak said.

Irreconcilable contradictions

In April 2020, the OPEC+ member states made a decision on an unprecedented production cut after the demand dropped by 25% due to the COVID-19 pandemic. The decision was taken for the following two years, but with a gradual increase in production. As part of the first stage (May-June), the reduction was supposed to be 9.7 mbd to the level of October 2018 (with separate volumes defined for Russia and Saudi Arabia: 11 mbd). The second (August-December 2020) and third (January 2021-May 2022) stages assumed cutting the oil production by 7.7 mbd and 5.8 mbd, respectively.

However, before the October meeting of the monthly OPEC+ Joint Ministerial Monitoring Committee (JMMC), the Western media reported that Saudi Arabia could offer other member states to consider a delay of the third stage of the deal by three or even six months. The reason is the resumption of quarantine in Europe and the US, which had a negative effect on demand. The idea did not find proper support among the OPEC+ member states, in particular the UAE and Russia.

Russian oil companies agreed to extend the current restrictions only for the first quarter of 2021. Just before the OPEC+ meeting on November 30, Mr. Novak and the Saudi Minister of Energy, Prince Abdulaziz bin Salman, convened an informal meeting of the JMMC, where Kazakhstan admitted that it was difficult to comply with the agreement under the existing restrictions. Later it turned out that Nur-Sultan still supported the position on extending the restrictions for the first quarter of 2021, but one of the key conditions was the easing of existing quotas.

Finally, the member states have adopted a decision, which allows them increase the production by 0.5 mbd beginning from January 2021. At the same time, all ministers meet every month and can make additional decisions on adjustments, but not more than 0.5 bmd each month.

“Despite the difference of opinions, we could develop a common compromise option that allows us to confidently continue our joint work on balancing the market under current realities,” Mr. Novak said.

Among the positive factors for the market, he also called "the certainty with the US elections", and a negative one - low demand in winter and new restrictive measures in many countries to combat the second wave of the pandemic.

As for the further increase in oil production, Russia expects that by April 2021, it will be possible to return to the implementation of the third stage of the deal. “I hope that this will happen during the quarter - adding 500 tbd each month, by April we will reach 2 mbd, if there are no force majeure circumstances,” Mr. Novak said.

Saudi Arabia's Energy Minister Prince Abdulaziz bin Salman pledged to actively pursue sustainable oil market stability "to which both producers and consumers strive."

"Payments on accounts"

Another outcome of the last meeting was that the OPEC+ member states that could not fulfil their obligations were given another three months to accomplish the task. In this regard, Prince bin Salman noted that the decision to increase oil production could help some countries to compensate for previously undercut volumes. Since May, Iraq, Nigeria, Gabon, Angola, and Algeria have followed the deal the worst. The total volume of unfulfilled obligations reached 2.4 mbd.

Earlier, the "violators" were allowed to compensate the volumes not cut in May-July by reducing production in addition to their quotas during August-September. But even in these months, some countries (e.g. Iraq) did not fully implement the agreement. After that, the “violators” were allowed to compensate for the volumes until the end of the year. Moreover, Iraq and Nigeria, according to the latest data, increased production again in October.

Confident growth

Meanwhile, benchmark oil prices are showing solid growth. On December 10, for the first time since the beginning of March 2020, February futures for Brent and WTI exceeded $50 and $46 per barrel, respectively. The market was supported by the outcome of the OPEC+ meeting, as well as the signals that the US may soon take another package of measures to support the economy, and the optimism associated with the coronavirus vaccine.

Given the specifics of oil as a commodity, forecasts on prices may often prove wrong but the analysts have almost similar views on the next year. It is clear that no one is expecting either a rapid takeoff or a collapse. Most experts agree that the oil prices in 2021 will remain around $45-60 per barrel, since the demand is still weak, and there is no complete clarity in the situation with the coronavirus and vaccines. The increase in oil production in Libya, as well as the possible return of Iran to the oil market can worsen the situation. At the same time, it is clear that OPEC+ will continue playing an instrumental role in the stabilisation of the oil market in the future.

By the way, Iran has already decided to begin preparations for launching oil production and export at full capacity within three months in case the Biden administration eases sanctions. According to experts, Iran is currently exporting less than 300,000 bpd, up from a peak of 2.8 million bpd in 2018. J. Biden, who is due to take office on January 20, 2021, said he would return to the nuclear deal with Iran and lift sanctions if Tehran strictly follows the terms of the deal. If the new US administration keeps its word, then Iran's return to the market is a matter of time, but this will most likely happen not earlier than after a year.

Fitch Ratings expects Brent prices next year to average $45 per barrel. As Fitch analyst Dmitry Marinchenko explained, the agency expects oil demand in the first half of 2021 to remain weak, as mass vaccinations in different countries will take some time.

Analysts at Moody's are equally cautious about oil prices in 2021. According to the agency's forecasts, oil prices next year will be at $40- $45 per barrel. “The increase in oil prices in 2021 will be insignificant, and this will lead to a limitation of capital investments by production companies, which will negatively affect the oilfield services sector and the midstream segment (storage and transportation). At the same time, the demand for oil will grow, but will not return to pre-crisis levels,” Moody's said in its review.

Surprise for the budget

In addition to American oil producers, maintaining relatively high oil prices is primarily in the interest of countries, which consider oil as the main source of export income. The Russian government, for example, hopes that the OPEC+ agreements will make it possible not only to fulfil plans to replenish the budget, but also to replenish the National Welfare Fund (NWF).

In Azerbaijan, state budget revenues for the next year are calculated using the baseline oil price of $35 per barrel. Obviously, the government is very interested in the increase of the global oil prices and supports all measures to ensure this growth. Azerbaijan has supported all OPEC+ decisions to cut oil production, including the last one, and has fully fulfilled its obligations under the OPEC+ agreement.

By the way, in accordance with the new OPEC+ deal, in January 2021, Azerbaijan pledged to reduce oil production by 123 tbd to 595 tbd. Since Azerbaijan must reduce oil production by 131 tbd, the new conditions will allow Azerbaijan to produce and export in January 8,000 bpd more than the current level. The price for Azerbaijani Azeri Light has already reached $51.7 per barrel. If the current price level remains in January and in the subsequent period, this will definitely have a positive effect on Azerbaijan’s export revenues.