OPEC Deadlock Leaves Market Guessing
On July 5, the Organization of the Petroleum Exporting Countries (OPEC) and allied producers canceled a planned meeting, leaving the group without a clear plan to raise output after August 1. An internal rift is raising questions over the group’s cohesion and market messaging, at a time when demand is growing, and OPEC states want to take advantage of higher prices.
Q1: What happened at the OPEC meeting?
A1: OPEC and the broader OPEC+ group failed last week to agree on a new plan to raise production. For months, the group has been unwinding its largest-ever production cut, instituted in April 2020 at the peak of the Covid-19 oil demand shock. OPEC+ had agreed to add 2 million barrels per day (b/d) to the market from April to July, and Saudi Arabia has also been tapering its unilateral 1 million b/d cut. The group needed to agree on a production plan beginning August 1 and planned to add more barrels into a market showing relatively robust demand. (Brent crude surpassed the $75 per barrel mark several weeks ago.) Saudi Arabia and Russia presented a proposal to add 400,000 b/d each month from August to December 2021 and to extend the current OPEC+ agreement from its current expiration in April 2022 to December 2022. The United Arab Emirates (UAE) balked at this proposal. It agrees with the planned production increases but refuses to extend the OPEC+ agreement without an adjustment to its reference production volume, or its baseline. The UAE’s refusal created a deadlock (OPEC agreements must be unanimous), and talks were extended from last Friday to Monday and subsequently called off. The energy ministers of the UAE and Saudi Arabia reinforced their positions over the weekend.
Q2: Why is the UAE taking such a hard line?
A2: The UAE has made a fundamental shift in oil policy, and it is losing patience with production restraint. This fight was inevitable, given Abu Dhabi’s growth plans, but it has worsened quickly. The UAE’s reference production volume is just 3.168 million b/d, but it claims its current production capacity is 4.2 million b/d, and it plans to raise capacity to 5 million b/d by 2030. The UAE has made substantial investments in raising output, signing numerous joint ventures with foreign companies and licensing new oil and gas blocks. Unlike Saudi Arabia, where the government sets an explicit maximum sustainable capacity and sees strategic value in maintaining unparalleled spare capacity, the UAE plans to raise output, not keep barrels offline. Another significant factor is that Abu Dhabi has launched a futures contract for its Murban crude to establish a freely traded Middle Eastern benchmark without destination restrictions. Market trust in the Murban futures contract depends on liquidity and reliable volumes, adding pressure for the UAE to produce more crude. The UAE is now refusing to extend the OPEC+ agreement and wants a higher baseline of around 3.8 million b/d, arguing that it has kept one-third of its production idle since last April.
Q3: What happens now?
A3: OPEC canceled its July 5 meeting and has no immediate plans to reconvene. Without a consensus agreement, in theory, OPEC+ would have no choice but to leave production volumes unchanged from August to December of this year, which could overheat the market and cause oil prices to rise. However, the greater risk is that without an agreed production increase, countries would ignore their existing targets and produce more to take advantage of higher prices. This would erode the hard-won discipline of recent years, especially the group’s production restraint during the Covid-19 crisis. Speculation that the OPEC+ framework could fall apart is probably overblown, but this is a serious internal rift. It is even more striking that the key dispute is between the UAE and Saudi Arabia—allies that are usually closely aligned on OPEC policies. The problem for OPEC+ is that allowing one member to alter its baseline—for example, basing its reference volume on April 2020 production instead of October 2018—would invite other countries to seek similar accommodations. Saudi Arabia, as the de facto head of OPEC, wants to maintain cohesion, and exceptions for one country set a poor precedent. Settling on an alternative date for reference production volumes would create winners and losers within the group and would entail painful negotiations.
Q4: What compromises are possible?
A4: There is good reason to believe that OPEC+ can cobble together an interim agreement. Indeed, the longer this stalemate drags on, the greater the concern that OPEC will lose control of the market narrative. (Although the current agreement remains in place, so the current situation is not yet comparable to last year’s painful price war.) Fundamentally, there is agreement within the group that a production increase is necessary. One potential compromise is that OPEC+ agrees to the mooted production increases this year, while dropping plans to extend the agreement from April to December 2022. It could use the interim period to negotiate with the UAE over its baseline. Since it is difficult to predict the state of the market next April, this seems like a reasonable outcome, but it would not address the core issue of the UAE’s baseline. Having made these demands, the UAE is unlikely to back down. To keep the UAE onside, eventually, Saudi Arabia, Russia, and others will probably have to make some concessions and allow it to produce more. The implicit threat from the UAE is that if it feels OPEC membership conflicts with its national interests, it will be prepared to walk away. All sides surely want to avoid this outcome.
Q5: How will this affect the United States?
A5: Rising gasoline prices are usually an unwelcome sight for presidents, and pump prices have been rising in recent weeks along with global crude prices. On Monday, the White House stated that it is monitoring the OPEC+ negotiations and has “been engaged with relevant capitals to urge a compromise solution that will allow proposed production increases.” Prices for West Texas Intermediate (WTI), the key U.S. crude benchmark, rose above $75 per barrel last week, although they have now fallen back. The run-up in oil prices has implications for producers as well as consumers. In the first half of this year, shale operators in the United States have maintained capital discipline despite a more favorable oil price climate. They are on pace to deliver substantial free cash flow this year after many years of failing to generate enough free cash to cover capital expenditures and dividends. But if WTI remains above $70 per barrel, the temptation to ramp up production will certainly grow. Containing U.S. shale growth is one of the reasons why OPEC+—and particularly Russia —would like to avoid a price spike.
Ben Cahill is a senior fellow in the Energy Security and Climate Change Program at the Center for Strategic and International Studies in Washington, D.C.
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