In the coming weeks, Saudi Arabia and its OPEC+ allies face a crucial decision: whether to move forward with planned production increases starting in October or delay them due to an uncertain economic outlook.
Recent declines in Brent futures prices, calendar spreads, and refinery margins have heightened concerns about petroleum consumption. These developments highlight the risks associated with increasing production amid downward revisions to consumption growth and rising output from competitors like the U.S., Canada, Brazil, and Guyana. An increase in production could lead to higher inventories and lower prices.
Conversely, delaying production increases could result in losing market share to competitors in the Western Hemisphere and might prompt some OPEC+ members to raise output independently.
Planned Production Adjustments
Since late 2022, Saudi Arabia and other OPEC+ members have been implementing production cuts to manage excess petroleum inventories and support prices. The official collective cut of 2 million barrels per day (b/d), agreed upon in October 2022, was aimed at addressing economic and market uncertainties.
In addition, voluntary cuts of 1.66 million b/d agreed in April 2023 and another 2.2 million b/d agreed in November 2023 were intended to stabilize the market. Starting in June 2024, OPEC+ ministers planned to gradually unwind these voluntary cuts, beginning in October 2024 and concluding by September 2025. The United Arab Emirates is set to increase its output by 300,000 b/d starting January 2025, with the plan extending until September 2025.
Under this plan, total OPEC+ production is expected to rise by approximately 180,000 b/d each month in the fourth quarter of 2024 and by 210,000 b/d each month in the first nine months of 2025. However, ministers have stressed that these increases are conditional and could be adjusted based on market conditions.
Market Indicators
Oil prices and spreads are currently weaker compared to when the second set of voluntary cuts was agreed upon in November 2023. August 2024’s inflation-adjusted Brent futures averaged $79 per barrel, down from $84 in November 2023. Brent’s six-month calendar spread has averaged a backwardation of $2.50 this month, stronger than the $1.63 observed in November.
However, inflation-adjusted refinery margins have decreased from $24 in November to $22 this month. Other price indicators suggest a rough balance between production and consumption, with several weakening since the June 2024 decision to increase production.
Inventory Levels
As of the end of June, commercial stocks of crude and refined products in OECD countries totaled 2,761 million barrels, 120 million barrels below the ten-year seasonal average. This deficit has nearly doubled since November 2023. U.S. commercial crude inventories have continued to decline more rapidly than usual since late June, indicating a tightening market.
U.S. crude inventories fell by 35 million barrels in seven of the eight weeks following June 21, with the depletion this year being the second-largest in the past decade. The deficit in U.S. crude inventories was 9 million barrels below the ten-year average as of August 16, down from a surplus of 6 million barrels in June.
Investor Positions
By early August, portfolio investors had reduced their positions in crude and fuels to some of the lowest levels since 2013. Hedge funds and other money managers held a combined position of 226 million barrels as of August 13, down from a high of 524 million barrels in early July. This reduction reflects increased uncertainty about major economies and global oil consumption.
If the planned production increase is already reflected in prices, deferring it could lead to a price rally as fund managers rebuild positions. Conversely, if the increase is not priced in, proceeding with it might cause further price declines as funds sell more contracts.
Strategic Considerations
The global economic outlook for the remainder of 2024 and 2025 looms over these decisions. With global manufacturing and freight activity stagnating, petroleum consumption has grown more slowly than anticipated. Central banks, including the U.S. Federal Reserve, are expected to lower interest rates to stimulate spending.
OPEC+ must weigh whether to focus on current economic softness, which suggests postponing increases, or on anticipated recovery and stimulus, which could support proceeding with production hikes. The cautious approach would be to delay increases until the economy strengthens and oil prices rise. Alternatively, OPEC+ could proceed with the planned increases, challenging the skepticism of hedge funds.