Reliance on supply management remains a governing characteristic of the oil market. Never easy but remarkably successful since January 2017, the management of oil supply grows more difficult with time.
The market went 2 years without supply management and became chaotic, devastating oil producers. Desperation led members of the Organization of Petroleum Exporting Countries to agree late in 2016 to reinstate production restraint with help from a group of nonmember producing countries. Fear of renewed chaos holds the agreement together.
All producers benefit from the consequent oil-price stabilization, while producers limiting supply lose market share. For production cutters, the price effects apparently warrant the sacrifice so far. When they no longer see value in the tradeoff, supply management will weaken.
Pressure grows
Pressure is growing. In its July Oil Market Report, the International Energy Agency said global supply exceeded consumption by 900,000 b/d in 2019’s first half. It estimated the surplus at 500,000 b/d in the second quarter, for which it earlier projected a deficit of the same amount.
Firming of the market, absent a surprise blow to production, is not in sight. Oil supply from outside OPEC consistently grows faster than demand, lowering what market watchers know as the call on OPEC crude. While Venezuela’s production plunge and sanctions on Iranian oil exports lower amounts by which other OPEC members must cut output, the cushion won’t last forever.
A darkening picture emerges from trends in estimates of what the market needs from OPEC and its collaborators—the group nicknamed OPEC+. Factors in the calculation are uneven because the call on OPEC is crude only, while supply from collaborating countries includes gas liquids and other noncrude hydrocarbons. But adding collaborators’ total supply back to the call on OPEC crude approximates the market’s need for oil from the group. That value’s share of oil demand indicates the group’s market weight.
In 2017, this notional call on OPEC+ supply represented 52.3% of global demand in the first quarter, 52.7% in the second quarter, 51.9% in the third quarter and 51.5% in the fourth quarter. Since then, the percentages have steadily fallen quarter-to-quarter. This year, according to IEA projections and OGJ calculations based on assumptions about non-OPEC collaborator’s supply beyond the second quarter, the corresponding numbers are 48.9%, 48.7%, 48.9%, and 48.4%. They’ll fall below 48% in all four quarters next year.
The market’s need for OPEC+ oil thus falls steadily, eroding the comfort OPEC receives from involuntary Venezuelan and Iranian cuts and ensuring more voluntary cuts will be needed. Commitment of OPEC+ participants to the production accord will be tested.
Still most important to the agreement is compliance by production leaders Saudi Arabia and Russia, which together account for 40% of OPEC+ supply. Adherence to the production agreement by one megaproducer probably depends on adherence by the other. To this essential balance, bilateral relations obviously are crucial.
Since 2016, those relations have warmed. Historically, Saudi Arabia and Russia more often have been adversaries than friends. And, at least until recently, Saudi Arabia usually sided with the US in conflicts involving Russia. But cooperation on production seems to have eased the chill. Saudi King Salman made an unprecedented visit to Moscow in 2017. The meeting yielded agreements to cooperate in several areas, including energy. And Russian President Vladimir Putin showily greeted Crown Prince Muhammad bin Salman at a G20 meeting in Buenos Aires last November. That was important because other leaders kept their distance after the October killing of dissident journalist Jamal Khashoggi in the Saudi embassy in Istanbul.
Geopolitical touchiness
The countries still clash over Syria and Iran. But Moscow clearly hopes to capitalize on US disengagement and increase its influence around the Persian Gulf. Riyadh might see a chance to weaken Russian support for Iran.
Geopolitical touchiness thus buffets the Saudi-Russian reciprocity essential to OPEC+ supply management. It’s a factor of risk to the production accord—and therefore to stability of the oil market.
