As Oil Demand Recovers, OPEC’s Discipline Will Be Tested

“THE ASKS the picture showed clear signs of improvement. So said Abdulaziz bin Salman, Saudi Arabia’s energy minister, at a virtual gathering of the Organization of the Petroleum Exporting Countries (OPEC) on June 1. The cartel and its allies, foremost Russia, have been hit hard by the covid-induced recession, which reduced global oil demand from nearly 100 million barrels per day (bpd) in 2019 to 91 million. last year. In a frantic effort to prevent a price crash, OPEC+, as the group calls itself, agreed to cut production in early 2020. Still, it failed to prevent the price from falling below $20 a barrel (see chart).

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Today, the cartel believes oil demand is finally on track to recover. Ministers agreed to increase supply by around 450,000 bpd in July, as part of their plan to restore almost half of the production cuts made last year. Saudi Arabia, which has the lowest production costs and the most unused capacity in the cartel, and often acts as an alternative producer, has indicated that it will also soon reverse a unilateral production cut of 1 million bpd. made earlier this year.

In response, the price of benchmark Brent crude rose above $70 a barrel on June 1 for the first time in two years. Several indicators confirm the idea that the demand for oil, a proxy for economic growth, is taking off. Oil inventories, which exploded last year, are down sharply. The International Energy Agency, an official body, estimates that global oil demand could return to pre-pandemic levels within a year. In America, gasoline demand surged over Memorial Day weekend at the end of May, a robust start to its summer “driving season.”

OPECThe celebrations of may yet turn out to be premature. A drag on prices could be Iran, where production has been curbed by US sanctions. Speculation that talks to revive a deal over Iran’s controversial nuclear program could soon progress has proven unfounded. This delay means that additional Iranian oil is not about to suddenly flood the market. But if a deal is struck one way or another this summer, analysts estimate Iranian exports could increase by 1 million bpd or more by the end of the year.

Moreover, although tight inventories and strong demand will push up prices in the near term, those same prices will cause US shale oil producers, who are currently limiting investment, to splurge. Saudi Arabia may also find it harder to keep OPEC disciplined, observes David Fyfe of oil argus, a specialized journal. Members tend to stick to agreed discounts when demand slumps, but rising prices encourage cheating.

Greater concern, says Paul Sheldon of S&P Global Platts, an analytics firm, is “unexpected pullback in demand” in 2022. America and China are back to their gas consumption habits thanks to the spread of vaccines; Europe is no exception. But energy demand in India and Latin America, where the pandemic is still raging, remains fragile. Mr. Fyfe points to long-haul transport as another source of weakness.

The most serious threat to the cartel comes from technological change. There are widely differing views on how quickly demand for black products will give way to greener fuels, even among the oil majors. But oil suppliers will almost certainly find a carbon-constrained world difficult. Edward Morse of Citigroup, a bank, makes a more subtle point about innovation. Oil could climb to $80 a barrel in the short term, but this is not the start of a “new secular bull run”: the global cost of finding and exploiting oil has more than halved over the past five years to reach 10 to 15 dollars. per barrel, he estimates the fair value of crude to be $40 to $55. The “clumsy cartel”, as Morris Adelman, an energy economist, once dubbed it OPEC, is ready for a rocky ride.

A version of this article was posted online on June 2, 2021

This article appeared in the Finance & Economics section of the print edition under the title “The Clumsy Cartel”

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Felix J. Dixon