ARABIC GAMBLE

The oil crisis that once pushed the OPEC and non-OPEC member states to reduce price volatility and establish a relatively strong balance between supply and demand for oil is a thing of the past. A year passed since the last OPEC+ deal, making the market situation undergo dramatic changes: the price of oil, which fell to $23 per barrel in March 2020, soared to $75, although it did not even reach $70 before the pandemic.

However, the global rise in prices brought new problems, as expected. Many market participants forecast possible overheating in the market. The COVID-19 pandemic, the effectiveness of the vaccination campaign, the pace of global economic recovery, as well as the possible lifting of sanctions on Iran, which would bring at least 1 million barrels of oil to the market, remain the key uncertainties for the global oil market.

Emirates attack

Part of the concern was also related to the expectation that, in the context of high prices, producers outside the OPEC+ could increase production. Thus, the cost of production of American shale oil fluctuates at the level of $45-55 per barrel, while too high quotations can increase the production of oil in the US quickly enough, winning the market share from the self-limiting OPEC+ states. However, in addition to the US, there are also oil producers that are increasing production, including Norway, Canada, Brazil, etc.

There are also tensions within the OPEC+ alliance: the member states are now unable to agree on the further cut of oil production. There is a heated debate about how exactly to extend the deal, also because of the position of the UAE, which asked for new conditions for itself.

Abu Dhabi, always considered a staunch ally of Riyadh, effectively blocked the option of extending the deal proposed by Saudi Arabia and Russia, calling its quotas to cut oil production "unfair". As a result, the latest OPEC+ talks at the ministerial committee level, trilateral negotiations and the full-scale ministerial meeting 1-2 held on July 5 were not as successful as the market expected - a final decision to increase oil production in August-December 2021.

In April 2020, OPEC+ agreed to cut oil production by 9.7 mbd until May 2022 with a gradual decrease to 5.8 mbd in January 2021. But in fact, in May-July 2020, oil production was reduced by 9.7 mbd, by 7.7 million in August-January 2021, and by only 0.5 mbd in January... Then the member states only increased production and could decrease the production volume to 5.8 mbd by July 2021, contrary to what was expected in January 2021.

Even before the ministerial meeting on July 1, it became known that the leaders of the OPEC+ - Russia and Saudi Arabia - are in principle ready to increase oil production. They reached a preliminary agreement to gradually increase production by 2 mbd until the end of 2021 (i.e. by 400 tbd monthly from August to December) and to extend the deal until the end of 2022 in order to achieve greater stability in the market.

Angola's Energy Minister Pedro Azevedo, in his opening remarks at the OPEC conference, noted that “it is important to continue the OPEC+ Declaration of Cooperation and our careful monitoring efforts to avoid any possibility of a significant oversupply in 2022. Looking into the future, we are faced with uncertainties arising from political measures, investor activity and litigation that could negatively affect the ability of our industry to invest in production, technology and human potential,” Mr. Azevedo said.

It was expected that the negotiations of the ministerial monitoring committee will not be easy, because the meeting began with a delay of several hours. Nevertheless, no one expected such an outcome. During the meeting, the UAE supported the increase in production beginning from August and expressed its readiness to remain committed to the deal until April 2022. But at the same time, the UAE representative said that they would not support the extension of the deal on limiting oil production after April 2022, if the country's reference base for reducing production is not increased from 3.168 to 3.8 mbd. That is, in fact, the UAE asked to increase its production by 600 tbd, which is quite a significant volume for the global oil market. It was this condition that brought the outcome of the meeting to a standstill.

Compromise or justice?

In fact, when the deal was concluded in April 2020, OPEC+ member states agreed on benchmarks volumes of oil cuts. For Russia, this level was set at 11 mbd, which is higher than its maximum production. Saudi Arabia agreed on the same level, which is below its maximum, but above its real production capacity. Other countries, including the UAE, agreed on the October 2018 level. However, this turned out to be extremely unprofitable for the UAE - in October they produced 18% less than they could.

“Some believe the UAE has been mistreated at some point in the past (OPEC+ deals - R+). Some consider the possibility of increasing production amid a decline in the benchmark base," commented on the situation the Iranian Oil Minister Bijan Zangane.

Later, a spokesman for the State Oil Company of Abu Dhabi explained that the UAE was committed to working with OPEC and supports the proposed collective production deal. However, they want their own quota to better reflect their production capacity. “We don't want to flood the market, but there is demand for oil,” he said.

Prince Abdel Aziz bin Salman, Saudi Arabian Energy Minister, called on the UAE delegation for "compromise and rationality", but his call went unheeded. Expectations that all disagreements could be overcome and the decision to increase production would be made on July 5 turned out to be in vain. Talks to increase production by OPEC+ member states were postponed indefinitely.

According to leading world media outlets, the UAE's intransigent position on the further terms of the OPEC+ deal is linked to Abu Dhabi's new strategy: to sell as much oil as possible here and now, while demand and prices are high. The country hopes that these revenues will help the UAE to get away from oil dependence.

Shall we expect a new deal?

Despite the current tension within OPEC+ and the futility of recent negotiations, the situation is unlikely to lead to the collapse of the deal. It is likely that due to the absence of any agreement in August the parties will continue to cut oil production on current terms. Given the growing demand, this, however, can lead to a shortage in the oil market and an increase in prices.

A scenario, when the OPEC+ member states do not want to remain committed to the July quotas in August, but increase production at their own discretion, seems more realistic.

The US Department of Energy, for example, assumes that OPEC+ will continue to increase oil production after July. "We expect OPEC+ will not further cut production to offset any potential increases in production by Iran or Venezuela," the agency's Energy Information Administration (EIA) said in its July report.

On the other hand, an uncontrolled increase in production can easily bring down oil prices, and OPEC+ is well aware of this, especially after the events of last year. So OPEC+ will definitely not allow a new price war in the market. Therefore, one of the most likely options is that the parties will return to the negotiating table in the near future and agree on the volumes of the subsequent increase with certain concessions to the UAE. In the current situation, a price war is disadvantageous to any of the participants, since it can greatly destabilise the situation in the oil market.

This is also evident from the words of bin Salman, who in his interview with CNBC pointed out that OPEC+ decisions to increase production should be balanced. “We shouldn't overdo it. If we do nothing, we will be acting carelessly. And if we overdo it, it is also negligence,” the minister said. By the way, he does not exclude that OPEC+ will hold the next discussion of the topic of increasing oil production in August. “Yes, it can be,” he said in an interview.

At the same time, according to the minister, the OPEC+ participants "have a full interest in supplying additional barrels to the market, and the faster the better."

Expert opinions on the future of the OPEC+ deal are different, although most of them believe that the matter will not end with a "divorce" and a compromise will be found.

According to them, the existing contradictions can be resolved by an agreement consisting of two components. First, OPEC+ can agree to increase oil production in August-December, and then discuss the extension of the deal on production limitation.

"If OPEC+ does not increase the volume of oil production, then oil prices will likely rise to $85-90 per barrel," concluded the FACTS Global Energy Group.

Experts recalled that a significant increase in shale production in the US should be expected next year, given the current high oil prices.

Moderate growth

Markets reacted to the failure of the OPEC+ ministerial talks through increased prices. Brent price exceeded $77 per barrel - a record value in the last 2.5 years. A number of experts believe that expensive oil can slow down the recovery of the global economy.

Prices are still under pressure, fluctuating between $71-$75 per barrel. Investors are still waiting for signals from the OPEC+.

Meanwhile, the US Department of Energy raised the forecast for the average price of Brent from $65.2 to $68.8 and from $60 to $67 per barrel in 2021 and 2022, respectively.

“Spot prices for Brent crude in June averaged $73 per barrel, which is $5 higher than in May and $33 higher than in June last year. In the coming months, oil production by OPEC+ may turn out to be higher than the level of oil consumption. We expect that production growth will slow down the constant decline in world oil reserves and keep prices at current levels - an average of $72 per barrel in the second half of 2021,” EIA reports.

UBS Bank experts do not exclude the possibility of increasing oil prices by September to $80 per barrel, taking into account the failure of recent negotiations, which may lead to an increase in the global oil deficit. "However, the alliance can still come to an agreement, given that OPEC+ members are likely to continue negotiations," the bank's analysts said.

After the price war waged by Saudi Arabia against Russia last year over the latter's withdrawal from the OPEC+ deal, the countries eventually found the strength to sit down and negotiate record production cuts to restore the balance of supply and demand in the market. At the same time, they had to make serious concessions to Mexico, which by its refusal almost threatened the conclusion of the deal. In fact, at that time Saudi Arabia assumed part of the obligations of Mexico. Now history repeats itself, only this time with a new performer as a rebel. Riyadh may once again have to take on some of the UAE's production increase commitments to keep the deal going. OPEC+ has more than once proven its effectiveness in regulating the oil market. Therefore, it is hard to believe that its participants can easily abandon it, letting the market take its course. The next meeting is likely to take place soon.