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Edward Bell - Senior Director, Market Economics
Published Date: 01 August 2022
OPEC+ will decide on new production targets this week after having agreed to return all of the output taken out of the market from the early months of the Covid-19 pandemic. The producers’ alliance initially agreed to cut production by an enormous 9.7m b/d in May 2020, phasing barrels back into the market over a timeline that was initially meant to end in April 2022 before being extended until September at a decision in July 2021. Since the start of the OPEC+ deal, oil prices have rallied more than 330% from USD 25/b for Brent futures at the end of April 2020 to USD 110/b at the end of July 2022. A disciplined approach to adding barrels back to the market along with a recovery in demand and draining of inventories have all helped to establish a solid fundamental floor for high oil prices.
From here, however, the path is less defined. The demand outlook is particularly hazy given that the US has now recorded two quarters in a row of a shrinking economy—the usual, but not American way of defining a recession—China maintains its strict Covid restrictions while the Eurozone and many emerging economies are struggling under the pressure of tightening monetary policy and high inflation. While oil demand will prove weaker during a broadbased slowdown, the kind of collapse markets endured in 2020—when consumers couldn’t leave their homes and travel effectively ceased—isn’t going to occur. Rather a year or two of low or mildly negative oil demand growth may be ahead of us.
At the same time, the supply picture for OPEC+ is much more challenging. One of its key members, Russia, is under sanctions from the US, UK, Eurozone and others and will see sanctions on its maritime oil exports come into effect later this year. But Russia remains part of OPEC+ and both the Russian energy minister, Alexander Novak, and his Saudi counterpart, Prince Abdulaziz bin Salman, pledged their commitment to “preserving market stability” at a meeting at the end of last week.
Beyond the restrictions placed on Russia to freely export crude oil and refined products, many members in the rest of OPEC+ are failing to hit their target levels as they run up against capacity constraints. Angola’s August target level of 1.53m b/d is 350k b/d higher than its June production as estimated by the IEA while the gap for Nigeria—a target of 1.66m b/d versus output of 1.17m b/d in June—is even wider. Outside of the core OPEC countries, the output gaps are also wide. Azerbaijan was more than 880% compliant with its June target level (meaning a wide underperformance) while storms and legal disputes have interrupted flows from Kazakhstan.
An agreement on higher oil output for September onward still seems likely as an outcome at the meeting this week. But in order for OPEC+ to preserve its integrity—and there has been no public statement from ministers that suggests it is in doubt—any agreement on higher production would have to include all members, even if the target levels are essentially notional. Allowing one or two members that have relative freedom of action to increase output—the UAE or Saudi Arabia for instance—would cast doubt on the whole point of the OPEC+ enterprise. Moreover, a higher output target also helps to keep consuming nations onside, not least of which is the US following the visit of President Joe Biden to Saudi Arabia earlier in July. During that visit Saudi officials stressed that any decision on oil output would be made within the framework of OPEC+, not unilaterally.
Our expectation that oil prices have entered a new era of relative scarcity remains unchanged and oil market fundamentals will support prices at higher levels than we have seen in the last few years. The improvement in oil prices since the peak of the pandemic should help to keep OPEC+ ministers committed to the effectiveness of the alliance and for now we see no change coming for OPEC+
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Monthly Insights - September 2022