There is economic life after the pandemic. While the novel coronavirus hasn’t been vanquished, oil demand has significantly risen in the past couple of months. According to the IEA, by the end of 2022 demand could have rebounded to pre-Covid levels.
Rising prices are causing mild distress in Moscow which fears that the global economic upturn could be slowed. While many uncertainties remain, sources expect Russia to opt for increased production during the OPEC+ meeting in a few days. At the start of the pandemic in April 2021, OPEC+ agreed on historic production cuts of 10 mbpd, which is approximately 10 percent of pre-Covid demand.
The oil cartel has gradually increased production by 2.5 mbpd until July to meet the global economic recovery. However, there is still some 5.8 mbpd spare capacity in reserve while the market is running a 3 mbpd deficit.
Russia, therefore, is expected to push OPEC+ to increase production even further as the price of oil continues to climb. Moscow is motivated by two arguments.
First, there is some fear that high-cost producers could be incentivized to increase production such as companies in North America’s shale patch. Second, not all Russian energy companies are supportive of the continued Russian Energy Ministry’s cooperation with OPEC.
As prices are rising, Russian energy companies are becoming increasingly unwilling to hold back production. Igor Sechin, CEO of Russia’s largest oil producer Rosneft, is known for his opposition towards production cuts in the OPEC+ context. Although he has remained relatively silent during the pandemic and supported cooperation with Saudi Arabia in general, expect the influential executive to opt for an easing of production restrictions.
In the past, tensions arose with the de-facto leaders of OPEC+, Russia, and Saudi Arabia, as there is a significant difference in their respective breakeven points. According to the IMF, Russia’s breakeven price is $46/bl while Saudi’s is $68/bl. As prices are comfortably above $70, an agreement could be reached. However, major uncertainties remain which will obscure the decision-making.
First, the ‘threat’ of the return of the Iranian oil industry has been hovering over the market since President Biden was elected and negotiations concerning the nuclear deal restarted. Second, the continued recovery of oil demand is uncertain as the feared Delta coronavirus variant is spreading, including in countries with high inoculation levels. Oil prices have stabilized as a consequence.
The positive news, from the perspective of OPEC+, is that international competitors appear uninterested in pumping aggressively. In the past U.S., shale oil producers were able to quickly ramp up production. Recently they haven’t been able to meet expectations meaning the rig count hasn’t risen significantly. According to Rick Muncrief, chief executive of Devon Energy, “the days of needing to grow at double-digit rates, that’s behind us. The industry has overbaked too many times.” Producers are holding production and instead are focused on increasing profits.
Furthermore, international competitors of OPEC+, such as Shell, Total, and others, are responding slowly to rising prices due to two reasons.
First, these companies have to consider their shareholders after a financially difficult year. Improving short-term profits, therefore, is more important than long-term revenue growth. Second, societal pressure in the West and activist shareholders are demanding more from the oil-majors concerning their decarbonization efforts. It is an important consideration as potential multi-billion investment decisions are a heavy burden for companies.
OPEC+ will be having some difficult discussions in the next couple of days as risks remain to global demand growth. Expect Russia to increase the pressure on Saudi Arabia as both have surpassed their breakeven prices. However, also expect restraint when it comes to opening the taps as uncertainties will remain with us for the foreseeable future.