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Oil price rise risks OPEC+ cheaters returning to old ways

February 11, 2021

OPEC+ members, including Russia, have been diligently sticking to their production quotas amid the extraordinary shock unleashed by the pandemic. Some of them might now be tempted to throw compliance out of the window.

A man rides a camel through the desert oil field and winter camping area of Sakhir, Bahrain
Experts say oil markets have gotten ahead of themselves given the still raging pandemicImage: picture-alliance/AP/H. Jamali

Oil prices are having a dream run as traders bet on vaccine rollouts, boosting fuel demand as economies reopen.

Benchmark crude contract Brent North Sea is trading at a year high of $61 (€53.1) a barrel, having soared over 60% since the emergence of successful coronavirus vaccines in November. West Texas Intermediate (WTI) futures, the US benchmark, has risen to $58 a barrel.

The increase in oil prices, however, could give Saudi Arabia, the de facto leader of the Organization of the Petroleum Exporting Countries (OPEC), a new headache; some of its fellow oil producers, which have been complying with pledged output cuts in keeping with a deal to stabilize oil markets, might now be tempted to go rogue.

"OPEC+ producers are anxious to ramp up production and higher oil prices will ultimately lead to massive cheating on production commitments," Edward Moya, senior market analyst at OANDA trading group, told DW. "For OPEC+ members, it is all about market share and if demand improves along with prices, we will see compliance go out the window."

Poor compliance has beset OPEC+ — an alliance between the oil cartel members and a handful of Russia-led producers — since its inception in 2016. Several alliance members, including Russia, Iraq and Nigeria, have been notorious for producing more than their pledged quotas, much to the annoyance of Riyadh, which has been left to do much of the heavy lifting.

A look back at stock markets in 2020

But when last year's COVID-19 travel restrictions and sweeping lockdowns battered oil demand and caused oil prices to crash, even trading below $0 a barrel in the US in April amid a severe shortage of storage space, oil producers didn't have much incentive to overproduce.

Saudi Arabia-Russia tension

OPEC+ has claimed that there was close to full compliance with oil production cuts between May and December under the terms of its current deal, with even the so-called laggards receiving an impressive report card. Saudi Arabia has been strict in ensuring compliance, even calling on those breaching targets to compensate in the following months.

The alliance agreed to the biggest coordinated cuts on record — 9.7 million barrels of oil per day (bpd), or 10% of total global supply — in April last year when the COVID-19 pandemic brought the global economy to a screeching halt. That figure has gradually decreased to 7.2 million bpd amid recovering fuel demand.

In December the grouping committed to gradually bring back no more than 500,000 bpd on a monthly basis. The increase in production was put on hold for February and March as many countries imposed new coronavirus lockdowns. Saudi Arabia volunteered to cut its production by an extra 1 million bpd in the two months as part of the deal.  

With oil prices breaching the $60 a barrel mark and crude stockpiles falling, Russia and some other OPEC+ members are calling for a faster ramping up of production than was agreed in December, reigniting tensions with Saudi Arabia. The group will meet on March 4 to discuss the production target for April.

"I do think that this meeting is going to be more difficult for Riyadh to argue for restraint, even though from a balanced perspective they [OPEC+] should restrain. So, make no mistake about that," Eugene Lindell from Vienna-based JBC Energy told DW. "The demand has not come back. So, the price is in a way artificially high. It's gotten ahead of itself. It's pricing more on future expectations than on current fundamentals."

Russia's shale worries

Russia, among the world's top three oil producers, has been calling on OPEC+ to ramp up production under pressure from its own producers, which are looking to cash in on the price rise.

Moscow, whose budget is more resilient to low oil prices than most major oil producers, is also worried that the recent increase in oil prices could lead to US shale players making a comeback after taking a battering during the pandemic, leading to further erosion in its market share.

Rystad Energy estimates that if WTI stays in the $50-55 per barrel range, then at least 300,000 bpd in oil production will be added by US shale companies by year-end 2021.

Moscow has already been receiving favorable conditions within OPEC+. It was allowed to produce an extra 65,000 bpd in February and March even as others, barring Kazakhstan, were told to hold output steady. Its undercompliance with pledged output cuts have also largely been ignored by Riyadh.

"As the oil price ticks up, they [Moscow and Riyadh] actually each have less leverage on one another. In a high market oil price environment, the two countries become less dependent on one another for market regulation," Rystad Energy oil markets analyst Louise Dickson told DW. "In a $60 per barrel world, Saudi's threat of releasing more than 1+ million bpd of spare capacity onto the market becomes less of a threat. At the same time, as prices tick higher, Russia's participation in the deal also becomes less crucial." 

Saudi Arabia's predicament

Saudi Arabia, which has been forced to dive into its cash reserves to meet its budgetary needs, would like oil prices to rise even further to help fund Crown Prince Mohammed bin Salman's ambitious spending plans as he looks to reduce the country's heavy reliance on oil.

"As long as this multi-billion project remains a top priority for the Kingdom, it may not have any better option than holding back oil production to fund it. Even if it has to go at it alone, as was the case with the 1 million bpd cut in February and March 2021," Dickson said.

Even if Riyadh manages to pacify calls for a faster raising of production targets, it knows all too well that there are bigger challenges waiting in the wings, not least the potential return of Iranian oil as the Biden Administration in Washington looks to bring back Tehran to the negotiating table to revive the Iran nuclear deal.

"It is amazing the production cut agreement has lasted this long. 2021 could see the return of Iranian and Venezuelan oil and that will complicate how everyone gets their fair share," Moya said. "Russia, Iraq, and Nigeria will likely be the ones everyone expects to break away from the agreement."

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Ashutosh Pandey
Ashutosh Pandey Business editor with a focus on international trade, financial markets and the energy sector.@ashutoshpande85