Where Does OPEC+ Go From Here?

Where Does OPEC+ Go From Here?


ASSOCIATED PRESS

The appointment of Prince Abdulazziz bin Salman as Energy Minister of Saudi Arabia of course has exploded the twitterverse with speculation about its meaning for the ruling family, the government and especially oil policy. The Prince is well known for his knowledge of the industry, unlike his counterparts in some countries, which in theory will be helpful to him and the country. But I’m tempted to say, ‘Good luck, you’ll need it,’ although I’m pretty sure he already knows that.

This Thursday Joint Ministerial Monitoring Committee will be at most a modest test of his thinking, but more likely his ability to get a consensus around a policy statement, given that oil prices seem to be range-bound at present. Brent has been above $60/barrel nearly all of 2019, even with a possible recession looming, and the meeting is unlikely to adopt a pre-emptive production cut.

In the past, such proactive moves were sometimes taken, such as in late 2003, when OPEC decided that weak markets in the 2nd quarter of 2004 needed quota reductions to prevent pressure on prices. Instead, soaring demand sent prices much higher, just another demonstration of how the uncertainty about the short-term direction of oil prices makes production quota setting problematical. (See my articles “Drivers of Oil Price Volatility,” Journal of Energy and Development, vol. XXVIII, no. 1, Autumn 2002 and “A New Era of Oil Price Volatility, Oil & Gas Journal, 2/12/2001).

Perhaps more important, coordination within OPEC and with non-OPEC producers has been much improved since the 1980s and 1990s. Then, a sharp price drop was met with serious delays when it was necessary to arrange meetings, get an agreement, and then enact agreed-upon cutbacks, often at the beginning of the next quarter. The attempt at setting a price band two decades ago, which would mean an automatic production response to prices which moved too far up or down, failed when prices fluctuated much more wildly than expected (mostly upwards).

In recent years, it has become much easier to get agreement on changes in production allowables when prices weaken, meaning the group has less need to try to predict and pre-empt market weakness. While a recession might only be visible in hindsight, oil price movements are immediate (if not always prophetic). So, this week’s meeting in Abu Dhabi should feel no great pressure to take significant action with regards to production quotas even though many think a recession—and weaker oil demand—is looming.

The biggest test for the Prince (and OPEC+) will come down the line. While it might be easy to agree on reducing production in response to a recession, at some point both Iran and Venezuela are likely to add millions of barrels a day to the market. When and how fast is not clear, but there is a very significant possibility that, combined with rising deepwater, shale and Iraqi production, only very strong demand growth will keep prices from dropping to a lower, more sustainable level.

This is what should be preoccupying the new Saudi Energy Minister in his spare time, assuming there is any. (The more important you are, the scarcer time is. See Herbert Simon’s theory of Bounded Rationality.) The biggest uncertainty concerns future shale oil production, whose growth is generally expected to slow markedly over the next few years. The figure below shows the evolution of medium-term U.S. oil production forecasts by the IEA, that have had to be revised upwards repeatedly. (All figures in mb/d) The current forecast, of approximately 0.5 mb/d/yr for five years is somewhat pessimistic, and the track record (of the IEA and everyone else) suggests the actual could again come in higher.

The author from IEA data

Overall, the same is true for non-OPEC supply forecasts, as the figure below shows. In general, I have argued for decades that there are a number of flaws in non-OPEC supply forecasting, including a tendency towards conservatism and an inability to predict smaller scale supply increments. Nearly all forecasts have tended to show a near-term increase and then decline, whereas the reality is that a sudden price drop causes a decline, but usually only a brief one. A peak in non-OPEC supply has been predicted—and overcome—for nearly four decades now and there is little reason to believe the situation has changed.

The author from IEA data

Which brings us to the most important—and uncertain—figure, the ‘call on OPEC,’ essentially representing the difference between demand and non-OPEC supply. The IEA’s five-year forecasts from 2015 to now are shown in the figure below, and it confirms the tendency to be optimistic in predicting higher need for OPEC oil, the 2015 price collapse being the exception. This is important because it does show how prices are one of two primary influences on the demand for OPEC oil, economic growth being the other.

The author from IEA data

If the IEA forecast is roughly correct, OPEC will see additional demand of less than 0.5 mb/d per year, which means that, after an expected Iraqi increase of 200 tb/d or so per year, there is not much growth left for the rest of the group. Since Iran and Venezuela have, between them, about 5 mb/d of capacity shut in, their return to world markets would almost certainly require major reductions by someone else. Lower prices might mean less shale production than projected, but it seems highly likely that other producers are going to be called upon to sacrifice production.

In 2012, I warned that $100/barrel was not sustainable and suggested $50-60 was a more likely long-term price (which was initially taken for a joke). Now, the success of shale oil producers makes it seem as if $60/barrel (Brent) (close to the current price) might prove to be too high, unless Iran and Venezuela remain largely excluded from world oil markets. Other producers might hope for that to occur, but they shouldn’t consider that the most likely scenario. Interesting times indeed.



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