At their recent meeting held in early December, a combined force of the Organization of Petroleum Exporting Countries (OPEC) and its partners, led by Russia, reached an agreement to cut their total production of crude oil to approximately 2.2 million barrels per day. This decision marked another effort by OPEC to bolster international oil prices, a strategy that has become a customary approach for the cartel. However, despite these ongoing efforts, reports suggesting OPEC’s diminishing influence have resurfaced. Nevertheless, premature assessments of OPEC’s declining significance may prove to be hasty once again.
Reuters recently reported that OPEC is anticipated to face reduced demand for its crude oil in the first half of the upcoming year. The report referred to oil demand projections from the International Energy Agency (IEA), the U.S. Energy Information Administration (EIA), and OPEC itself, which all indicated an impending weakening in demand for the group’s oil. This aligns with the earlier, albeit incorrect, predictions of an overall slump in oil demand issued by the IEA.
Furthermore, the primary reason the market did not exhibit substantial concern over OPEC+’s actions can be attributed to a few factors. Firstly, traders had already anticipated the production cuts, and secondly, global oil supply seemed plentiful. Additionally, the market was unconvinced due to historic instances of OPEC members disregarding production cuts. The likelihood of sufficient oil availability to meet demand, even if it were officially agreed upon to reduce production, rendered the market apprehensive about the effectiveness of OPEC+’s decisions.
Adding to these challenges was the announcement from Angola that it would withdraw from OPEC, giving the nation more freedom in determining its oil production quantities. This development further dented the unity within the cartel and reinforced the perception that regardless of the actions taken by OPEC and its allies, ample oil supply will persist, especially as demand weakens.
Many traders seemed to place significant emphasis on the projection of weaker demand, disregarding the fact that it takes several months for production cuts to noticeably impact the physical markets. Analyses of OPEC+’s December decision suggested that the planned three-month duration for the deeper cuts would likely prove insufficient to significantly affect supply levels and, consequently, oil prices. Commenting on this matter, Adi Imsirovic stated to Reuters, “I don’t think a three-month cut is long enough to make a meaningful difference in terms of physical supply even if everyone stuck to it.” Furthermore, another analyst mentioned, “Unfortunately, we won’t have an idea of January output until the end of that month, and this is a long time in the oil market,” emphasizing the delayed effects of such decisions. Callum Macpherson, the head of commodities at Investec, echoed this sentiment.
It is crucial to note that the current oil prices reflect the market’s focus on the present, rather than contemplating the state of future oil supply four months down the line. While not surprising, it is worth considering that these decisions often yield delayed consequences, similar to the cautious return to production growth by U.S. drillers.
In relation to U.S. drillers, they are often held responsible for OPEC’s struggle in influencing prices and the subsequent perceived loss of relevance. Indeed, U.S. oil producers surprised the industry this year by increasing daily output by one million barrels, thanks to improvements in well productivity, even as the rig count declined for most of the year.
However, it appears that many now assume the industry will sustain this level of productivity enhancements and continue expanding production. While this may occur, there is also the possibility that it may not. The EIA has predicted a more modest growth rate for this year, projecting an increase of less than 300,000 barrels per day. Although the EIA has been inaccurate before, particularly this year when its monthly forecasts for a decline in Permian output were proven wrong, limitations exist when it comes to ongoing well productivity improvements. Additionally, with corporate strategies now concentrated among a few major companies following a series of significant deals, production will align with the priorities of these large producers, and it may not necessarily involve continuous growth.
The recent reports proclaiming OPEC’s demise are predicated on assumptions of lower oil demand and perpetual U.S. output growth. However, neither of these factors can be regarded as certainties. Oil demand has persistently surprised observers by surpassing expectations since BP incorrectly declared peak demand had already occurred in 2019. Similarly, U.S. oil producers have displayed discipline and a newfound aversion to unbridled production growth.
All OPEC needs to do is exercise patience until demand naturally corrects the current comfortable supply levels often cited as the cause of weak prices. While OPEC’s global market share may have diminished due to the production cuts, its share still stands firm at 27% of the total. Moreover, with a spare capacity of approximately five million barrels per day, OPEC holds the option to utilize it if necessary. Reports of OPEC’s impending demise, once again, appear to be highly exaggerated.