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Several weeks ago (April 23), in a commentary cautioning OPEC against attempting to overcorrect an oil market that was already coming back in balance, we suggested that the upcoming (June 22) meeting of the OPEC-non-OPEC Alliance would likely include discussions on “unwinding or relaxing the current [freeze] agreement and making ready to resupply markets in the event of large-scale disruptions or imbalances.” In the intervening weeks, as a consequence of continued strong demand, the reduction of global stocks, deteriorating supply prospects in Venezuela and elsewhere, and the U.S. announcement of sanctions against Iran, oil prices increased to multiyear highs (around $80/barrel Brent) and forecasters were predicting that $100 oil was just around the corner. Media sources speculated that Saudi Arabia, in particular—in the final stages of planning for Aramco’s initial public offering—would welcome such increases, although we never found that argument particularly persuasive and noted that the downside for such a move (as discussed below) would far outweigh any near-term gain.
Several large consumers, including India and the United States, warned that precipitously higher prices were endangering global economic growth and that producers had to worry that sustained price increases would result in reduced oil demand, as well as incentivize new sources of supply going forward—recreating the “dreaded” surplus and driving prices down yet again in the not too distant future.
President Trump’s admonishment to OPEC and back-channel discussions with individual producers persuaded Saudi Arabia (along with Russia) to publicly announce a willingness to keep markets supplied and presumably make up for any supply shortfalls that could keep prices at elevated levels. That announcement, coupled with continued U.S. unconventionals growth (the Energy Information Administration projects that U.S. oil production will exceed 10.6 million barrels per day [mmb/d] this month) and lessened geopolitical tensions, produced a market “correction,” driving oil prices back into the mid-$70 range as speculative noncommercial longs liquidated some of their positions. Rumors of an apparent 1 mmb/d relaxation persist although individual ministers continue to assert that no agreement has been reached and that any final decision will be left up to the alliance at its Vienna meeting next week.
In the past two weeks, both Iran and Venezuela put fellow OPEC members on notice that they would oppose and resist efforts for other members to benefit from the “illegal” imposition of U.S. sanctions, in a veiled attempt to regain market share. Only a handful of countries currently possess significant “spare” capacity to replace lost Iranian barrels, with Saudi Arabia and Russia the most likely candidates. The announcement spurred some OPEC watchers to predict a most contentious Vienna meeting, certainly a plausible but by no means certain outcome.
So What Else Could Happen?
OPEC analysts continue to recalculate, using a variety of metrics (including most recently, a larger assessment of Chinese oil inventories, less optimistic forecasts of global demand, and possible escalation of trade wars following this weekend’s G7 debacle), what a “balanced” market looks like, thereby giving themselves an “out” for delayed or no further formal action to be taken at this time—save for the pledge to continue to monitor ongoing market conditions and step in as needed. Oil prices have already abated from previous highs, and sentiment, even in the absence of a relaxation agreement, may tend to keep oil in a tolerable band. And because of its overaggressive (and cumulative) compliance with the OPEC cuts for the past year and a half, Saudi Arabia could arguably produce several hundred thousand barrels per day of incremental oil going forward (depending on price and duration) and still remain in volumetric compliance with the agreed upon cuts. In fact, as the summer burn season approaches (Saudi Arabia still burns a significant amount of crude oil to generate power for cooling during the summer), we would predict that the kingdom will most certainly increase production this summer even if its crude export numbers don’t appreciably change. Last month’s reported production increase is largely attributable to this reality.
For its part, Russia is reportedly holding back exports, ostensibly to accommodate domestic demand during the upcoming World Cup. But if those barrels are not needed, they could also be available for export later at a potentially higher price. Russian producer activity has picked up of late, and even an informal relaxation of the alliance’s targets would likely result in increased “leakage” into global markets. Russian officials have even hinted that they might import/swap Iranian oil, freeing up Russian barrels for global buyers. Iraq (depending on politics and logistics), Kuwait, and the United Arab Emirates could also provide limited additional volumes without totally blowing up the “framework” of the existing agreement.
In addition, beyond the issue of volume is the question of sequence and timing. Assuming that European buyers of Iranian oil only gradually reduce purchases before the November 4 sanctions deadline (there are indications that Iranian oil production and exports were increased in the last two months prior to the sanctions announcement), and that Russia, China, and others Asian buyers would continue Iranian purchases, the volume of replacement barrels needed to offset any Iranian losses would still be substantially less than what was required to respond to previous multilateral sanctions. As a political matter for the United States, the prospect of finding a way to avoid/minimize further oil price increases carries the additional benefit of keeping domestic gasoline prices lower during the summer and placating voters as we enter the fall elections.
Of course, all of this presupposes the continuation of Venezuelan output. Should Venezuelan oil production fall off the cliff or should U.S. production be shuttered due to hurricanes or flooding, a number of alternative scenarios could come into play. The first of these would involve the suspension/abandonment of the OPEC freeze, but ostensibly under the rationale of saving the world from cripplingly economic impacts spawned by ever higher oil prices—a justification that avoids any direct confrontation with OPEC member Iran while still conferring obvious revenue benefits to that subset of producers capable of ramping up output on short notice. Such an event could also trigger the release of some portion of global oil stocks (held by the United States, China, and International Energy Agency countries, for example) or increased requests from certain allies for relaxation/waivers on purchases of Iranian oil. Given the president’s reception at the G7 meeting, we suspect that the administration is inclined to play hardball with sanctions relief requests even from historical allies, at least at this juncture.
The global oil market continues to evolve in both predictable and yet uncertain ways. Like previous OPEC meetings, next week’s discussions, including the emerging rifts between the larger members with spare capacity and those without such luxury, will need to be managed. Consensus forecasts appear to suggest further market tightening between now and the end of the year, raising prices for everyone. Market watchers appear to believe that a 400–500 thousand barrels per day “adjustment” is likely, but anything different could invite sentiment retribution. That said, while definitive action may yet be taken by OPEC come June 22, the prospect of kicking the can down the road cannot, as yet, be totally discounted.
Frank Verrastro is a senior vice president and trustee fellow with the Energy and National Security Program at the Center for Strategic and International Studies in Washington, D.C. Larry Goldstein and Albert Helmig are senior associates with the Center’s Energy and National Security Program.
Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).
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