OPEC+ may become the victim of its own success

At its meeting last week and contrary to expectations, OPEC+ confirmed current production levels for April, except for a limited increase of a total of 0.15mbd granted to Russia and Kazakhstan to meet seasonal consumption patterns. In addition, Saudi Arabia confirmed its unilateral reduction of 1mbd after the end of March, removing any time reference to the measure. The next OPEC+ meeting on 1 April will decide on production levels for May.

The rationale for OPEC+’s decision underlines the risks and uncertainties about demand and the need to manage supply cautiously to prevent a new increase in petroleum products inventories that would put downward pressure on oil prices. Despite lower Saudi production in February and March and the more than 1mbd drop in US production in the second half of February caused by the polar vortex, the first quarter of 2021 is expected to show only a moderate supply deficit (see Chart 1). Indeed, demand for petroleum products remains weak due to the Covid-19 containment measures still in place.

Chart 1. OPEC+ supply and Call-on-OPEC+

Source: Energy Information Administration, Refinitiv, and EFGAM calculations. Data as at 05.03.2021.

The expectation for the coming months, especially for the second half of 2021, remains for an upturn in oil demand, but this depends crucially on the progress of the vaccination campaign. OPEC+ aims to accelerate the disposal of the accumulated inventory overhang from 2020 by keeping oil supply below demand, thereby supporting prices.

The main risk to this strategy is its own success, when measured against crude oil price developments. For instance, the current WTI oil price is well above the level needed to incentivise a substantial increase in US production, which according to surveys by the Dallas Fed and the Kansas City Fed stands at around USD 56 pb. The longer it remains above this threshold, the greater the incentive for US and other non-OPEC+ producers to increase production.

Moreover, high oil prices are now more difficult to sustain than in the past. The falling cost of energy from renewable sources and its increased availability makes it much more competitive with fossil fuel energy.

Chart 2. US shale oil producers' threshold prices and WTI

Source: Dallas Fed Energy Survey and Refinitiv. Data as at 05.03.2021.

In conclusion, the surprising decision by OPEC+ to keep production levels unchanged has supported oil prices. However, the sustainability of high price levels depends on several factors, many outside the control of OPEC+. While it can fine tune its production levels, it can do little to prevent other producers with large spare capacity, such as in the US, from increasing supply when prices rise. In addition, high oil prices increase uncertainty about future demand levels, not least because they increase the risk of an accelerated transition to renewable energy sources.