In a move anticipated by market watchers, OPEC+ has once again prolonged its oil production cuts this month. The decision, while not surprising, has had the intended impact on prices, signaling a bullish trend. However, analysts caution that this strategy may have a limited shelf life, urging OPEC to contemplate its next steps.
Last year, the focus of oil traders revolved predominantly around demand concerns, particularly in China. Fast forward to the present, and there’s a shift in perspective. Withholding 2.2 million barrels of oil daily amidst a backdrop of increasing global demand suggests a potential strain on supply in the near future. Consequently, oil prices are witnessing an upward trajectory.
Although certain OPEC+ members have been exceeding their allocated quotas, efforts to address this through temporary deeper cuts have been initiated. Nonetheless, the issue of overproduction, coupled with the escalating output of quota-exempt countries like Iran, Venezuela, and Libya, hasn’t thwarted the efficacy of the cuts. However, it’s evident that this approach is not sustainable indefinitely.
Some industry analysts have argued that OPEC+ might need to start unwinding the cuts, particularly if Brent crude surpasses the $100 per barrel threshold. The rationale behind this viewpoint is that excessively high prices tend to dampen demand, thereby posing a risk.
Robin Mills, CEO of Dubai-based consultancy Qamar Energy, posits that OPEC+ might opt to maintain the cuts until oil prices surge well beyond $100 per barrel. In a recent opinion piece for The National, Mills outlined this as one of the potential paths forward for OPEC, forewarning of implications such as heightened inflation and increased U.S. production.
Alternatively, Mills presents another scenario where OPEC heeds its optimistic demand forecasts and decides to phase out the cuts. This perspective suggests a continued confidence in robust demand projections. Indeed, historical precedents, such as the oil price surge in 2022 amidst the Russia/Ukraine conflict, underscore the resilience of demand even in high-price environments.
While it may seem logical for OPEC+ to consider terminating the production cuts, maintaining the status quo might prove more prudent. This is particularly true given the potential impact on prices, akin to the effect of news revealing a significant uptick in U.S. shale output last year.
OPEC projects a 2.2 million barrels per day (bpd) increase in oil demand this year. With the production cuts in effect, this surge in demand is poised to push the global market into a deficit. Estimates of the magnitude of this deficit vary, with the International Energy Agency (IEA) anticipating a “slight” shortfall due to the OPEC+ cuts and enhanced demand resulting from geopolitical tensions in the Red Sea region. However, Qamar Energy’s Mills suggests a more substantial deficit of up to 4 million barrels daily later in the year.
In the event of such a deficit materializing, OPEC would have the option to either end the cuts or adjust them to prevent a price collapse. Notably, a deficit scenario presents an opportune moment for adjustments, as high prices and resilient demand would mitigate the impact of any policy changes. Nonetheless, it’s imperative to acknowledge that the cuts cannot be sustained indefinitely, especially with dissent emerging among certain OPEC members regarding their quotas.