By Dr Ajay Kumar
On December 3, 2020, OPEC+ managed to reach a production cut agreement decision after several days of increased domestic dissent over production cut. The commitment was reiterated that there is a continued commitment of the participating producing countries in the Declaration of Cooperation (DoC) to a stable market, the mutual interest of producing nations, the efficient, economic and secure supply to consumers, and a fair return on invested capital.
This is to know, that since April 12, 2020, a production cut agreement in consigning which has been slightly adjusted the last months. In the radiance of the current oil market fundamentals and the outlook for 2021, the group has agreed to reconfirm the obtainable commitment under the DoC decision to gradually return 2 million bpd, given consideration to market conditions.
There is no free market for oil. It’s controlled by a cartel, OPEC. Hence, January 2021 the members have decided to voluntary adjust production cut by 0.5 million bpd from existing 7.7 million bpd to 7.2 million bpd. At the same time, OPEC+ will be holding monthly OPEC and non-OPEC ministerial meetings starting January 2021 to evaluate market conditions and come to a decision on further production adjustments for the following month, with further monthly adjustments being no more than 0.5 million bpd.
The market indicates a positive index after the meeting. The outcome of the OPEC+ meeting has been welcomed by the media and speculators as a symptom of stability in pricing. The optimism about oil prices and economic recovery is boosted, as seen in the multitude of future oil price graphics spread on the internet. Relief is there that the OPEC+ cooperation is still together and able to move markets.
Still, some uncertainty should, however, be put in place, as the current decision and ongoing discussions inside of OPEC itself show a much more diffuse picture, where dissent and irrational optimism about markets could become a Trojan Horse or Virus, as not all heads are looking in the same direction.
What seems to be forgotten is that at present OPEC+ is the main problem of OPEC+. Continuing optimism about a possible oil market recovery in H1 2021 is not based on facts, but on two main other issues, wishful thinking of OPEC leaders, such as Saudi Arabia, and an irrational view on the positive effects on the global economy if COVID vaccines are being put in place. The economic effects of a global vaccination scheme, which is going to take 6-18 months due to logistics, financial restraints and political strategies, are going to be minimal in the short term.
To ramp-up price, better. Get. Lower. And it better. Get. Lower. Fast –The Production. So, OECD markets will not recover in H1 2021, as the availability of the vaccine is not at the required levels for a long period of time. At the same time, OPEC+ seems to misunderstand that OECD economies are on life-support, the government and EU wide financial support mechanisms are keeping the patient breathing. In 2021 most of these financial injections or QE mechanisms will be put on ice, as debt levels are reaching disastrous levels. A major economic downturn is to be expected, with its direct effects on oil and gas demand.
OPEC+ Countries main Oil Companies, they’re desperate for money. It means, the market is still struggling with an extremely high oil storage level, which is only partly decreased by high refinery runs lately. When looking however at the demand for petroleum products, the threat of storage build up on that side is imminent too.
As some analysts have rightly indicated, current oil price increases have nothing to do with OPEC+ strategies and decision-making but is mainly based on the (mis) perception of investors, traders and speculators that the COVID-19 vaccine will be hitting the market and bring back 2019 levels very soon. This wishful thinking has also been ingrained lately in OPEC leadership statements, which could lead to a self-fulfilling prophecy of deceit and defeat.
Even more worrying is the fact that internal OPEC dissent is growing, as the organization also seeks to get to grips with the fundamental distress in the market. For several main powers inside or linked to OPEC, the media-success story is one-sided and not anymore representing the facts on the ground. For almost all OPEC+ members, especially Saudi Arabia, UAE and Russia, the agreement has become a double-edged sword. Being the market stabilizer and swing producer has not brought the rewards targeted. Government budgets have been hit, the burden of cuts is not equally being divided, while a growing part of the participants is not willing to comply anymore. As a Chatham House report already indicated last weeks, dissent is growing as room for new revenue streams is needed. The current deal is not strong enough to quell the market, but the burden of all is on OPEC+.
At the same time, which is not reported at present, the new additional volumes agreed for the period January 2021 onwards, are not including the vast resurgence of Libyan and other production. It also doesn’t include possible negative effects of higher oil prices, which could lead to revamp of US shale and other production. Better to know, it’s the marginal cost that determines the price. It is a price war because basically, the OPEC reason did not cut production at the right time.
The exemption given by OPEC to some members, while non-OPEC is still free to act as it wants, is an open wound without a cure. OPEC itself also doesn’t admit the threat of a re-emerging Iran, a strong Iraqi production or lifting of sanctions by US incumbent president Joe Biden. The OPEC+ approach seems to have its own worldview, stating “if you don’t talk about it, it doesn’t exist”.
Vienna based analysts and OPEC leadership should quickly readjust their focus. OPEC internal dissent is clear, Abu Dhabi is just a primus-inter-paris in this discussion, but shows already that the Saudi-Russia-UAE bromance and power structure is eroding. Others will follow, as national stability and survival primes international compliance. With no real room for improvement, OPEC and oil markets should be bracing for a very difficult H1 2021. Oil prices will not be stabilizers but disruptors. The search for profit is short-term based, not locking existing threats and imminent destruction.
Vienna based OPEC should understand that its members are now looking like a bucket with frogs, jumping out if they feel like it. Without market power, not realized yet by OPEC and Moscow, the pain will be prolonged. OPEC leaders and Russia need partly to look in their own mirrors and admit that they have been not willing to acknowledge their own ostrich policies.
Abu Dhabi is also playing with fire, as it splits the cartel. Understandably maybe as peak oil demand is near, and market shares are down. It seems OPEC members are now trying to make sure that future market demand is going their way, forcing others to sit on stranded assets. Currently, however, the option of an oil glut is higher, markets should realize that the so-called deal is a diplomatic effort to present a “success story to the press”, while clearly members have been given the opportunity to do what they see fit to do. $50 per barrel is a present from Santa Claus, but he doesn’t exist as we all know.
The rising oil price is good for too many economies, as they earn to return –I mean –earn from oil bucket to invest in other sectors of their own county as per their need. Hence a production cut more is needed till March to ramp up the oil price, to achieve a better return for the investors’ money. For India, the low oil price may benefit the Government to earn taxes, but as India is not lowering domestic oil prices rather it is increasing and putting more burden on the public, it may lead to serious inflation which is not good in the long run.
Dr Ajay Kumar is Chairman of fox petroleum group.
The views expressed are his own.