Last weekend, OPEC and its partners, led by Russia, decided to extend their combined production cut agreement until the end of the first quarter. Nobody was surprised by that decision, and its effect on oil prices was limited.
But the longer the cuts continue, the more pressing one question becomes: how long can OPEC keep doing it?
The answer appears easy at first glance. OPEC, Russia, and the Central Asian producers can keep limiting their oil supply as long as it is necessary. Yet not everyone within the OPEC+ grouping is happy with the current arrangement, as evidenced by Angola’s recent exit from the cartel and the UAE’s individual quota adjustment after OPEC’s number three complained about the limits.
On a second, closer, look, the situation looks a little bit more complicated. Saudi Arabia, OPEC’s leader, is spending billions on diversifying its economy. It will need a lot more billions where the previous billions came from, which is oil. A few years ago, a Brent crude price of $80 per barrel was about enough for Riyadh to balance its budget, but with the inflation trends of the past couple of years and all those rate hikes, it might well need higher Brent for that balancing. Related: EV Charging Points in America Are Finally Making Money
This is what makes the position of both the Saudis and the whole OPEC+ group so precarious. The goal of the cuts, which first started in 2022, by the way, and only deepened in 2023, was to maintain a certain price level.
Back in November 2022, when the first round of cuts began, Brent was trading above $90 per barrel. But that wasn’t enough, hence the cuts. Now, oil is trading at around $80 per barrel. Despite more than a year of production cuts. And OPEC+ cannot back down now. As soon as it does, prices will slump. So, OPEC is losing market share to external producers, at least according to the International Energy Agency, and sitting on spare capacity.
There is a feeling among some energy analysts that the Saudis don’t have a good move here and would simply have to keep the lid on production, even at the expense of losing market share, in order to maintain some reasonable price level for their crude.
They often point to that massive spare capacity of some 3 million bpd in the kingdom alone as a big reason why benchmark prices have tended to brush off production cuts in the past two years.
But here’s the thing about this spare capacity: if it’s not used, it starts declining. And once it starts declining, bringing it back again would be tricky and expensive.
“For Saudi Arabia, which has consistently invested tens of billions of dollars per annum in its upstream [activities] over the past decade, idled capacity comes at a daily cost — it needs to come back on-stream,” Societe Generale’s global head of commodity strategy, Ben Hoff, told the Financial Times this week.
Saudi Arabia “can relatively promptly, and at a time of their choosing, bring back roughly 3mn barrels a day of idled supply [and] this potentiality is hanging over the market like the sword of Damocle,” Hoff said, reflecting popular analyst sentiment.
Yet Saudi Arabia simply cannot afford to bring back those three million barrels daily, not at this point. Prices need to go much higher before the kingdom begins bringing that spare capacity back online. Just how much of it would be left by that time depends on how long the cuts will remain in effect. Right now, it looks like they may well remain in place until the end of the year and possibly beyond that.
All the factors that kept pressuring prices last year are still around: slow economic growth, especially in China, high interest rates, and little prospect of upcoming cuts in the key markets, and, of course, IEA’s favorite: weak demand.
That last factor is the most questionable one of the three. Slow economic growth is a fact in many parts of the world, a legacy of the pandemic lockdowns and, in the case of Europe, the energy crunch of 2022. High interest rates are also a hard fact—central banks’ weapon of choice against runway post-pandemic inflation. But demand for oil has been consistently surprising in the years since 2020 and the great lockdown-prompted slump.
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This is where OPEC’s—and Saudi Arabia’s—chance is: in demand continuing to be as resilient to challenges as it has been since 2021. Back in 2021, demand rebounded a lot more strongly than most observers expected. Some, including BP, were even predicting that it would never rebound to 2019 levels. It exceeded those and continued rising.
As long as demand remains strong and growing, the oil market will swing into the deficit that OPEC’s leader needs to replenish its investment coffers and maybe raise production. This could, in fact, accelerate as early as next year, according to Occidental’s chief executive. Especially if the forecasts for much slower production growth in the U.S. materialize.
By Irina Slav for Oilprice.com
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While market fundamentals are solid and global oil demand is robust, they aren't reflecting what prices should really because of these manipulations. The majority of OPEC+ members need a Brent crude price of $90-$100 to balance their budgets.
Current OPEC's cuts of 2.2 million barrels a day (mbd) aren't what they seem. The Saudi cut of 1.0 mbd in place since June 2021 is no cut at all. I named it long time ago the cut that never was since Saudi Arabia can't anyway produce it the cut because of production difficulties. Saudi real production is estimated at 6.0-6.5 mbd. Moreover, it is a myth that Saudi Arabia has a spare production capacity of 3.0 mbd. It never had.
As for the remaining cuts of 1.2 mbd pledged last year by other OPEC+ members. I estimate that only an estimated 600,000 barrels a day (b/d) could have been implemented because of objections to these cuts among OPEC+ members. That is why Angola decided to drop its membership from January 2024. This means that the cuts are in effect only 600,000 b/d and not 2.2 mbd. It is too small to make a difference to prices.
Dr Mamdouh G Salameh
International Oil Economist
Global Energy Expert