By Greg Priddy

When they meet Dec. 5-6, the members of the OPEC+ coalition are likely to agree to extend current oil production quotas until at least the end of June 2020 and possibly longer, despite renewed media chatter on Dec. 2 suggesting the Saudis are considering supporting a deeper cut in support of the Saudi Aramco initial public offering. This outcome is at least mildly bearish relative to current market positioning, given the probability of a return to global oversupply in the first half of 2020. Despite being relative price hawks since 2016, Saudi Arabia seems to have accepted that it is not in a position to push others to do more, even as the final IPO price of Saudi Aramco will be determined Dec. 5.

The current stasis in OPEC+, a group of OPEC and major non-OPEC producers that are cooperating to manage output, reflects the results the group has experienced in the wake of its dramatic decision to make a "headline" production cut of 1.8 million barrels per day (bpd) in December 2016. After price fluctuations in 2017, oil sustained a rise above $70 per barrel in the first three quarters of 2018, with the global benchmark Brent crude oil hitting a peak of around $86 per barrel. This came even after individual quotas were dropped at the June 2018 OPEC meeting in the wake of the U.S. decision to exit the Iran nuclear deal and reimpose banking and oil sanctions on the country. A sharp price correction led to a 1.2 million bpd cut at the December 2018 meeting — creating a level where quotas remain today. The price recovery in the first half of 2019 peaked at $75 per barrel before plummeting into the current trading range in the upper $50s and lower $60s, where it has resided since mid-September except for the brief surge after the attack on Saudi oil facilities at Abqaiq.

Lower Prices, Higher Production

The price rise brought a surge of production growth, led initially by U.S. shale oil, which has a shorter lead time for development, but broadening to now include deepwater offshore production in several regions. After the price drop in mid-2019, the market is finally anticipating a sharp slowdown in the rate of U.S. growth next year as a result. Nevertheless, gains of around 200,000 bpd in Norway and 250,000 bpd in Brazil underpin the International Energy Agency’s forecast of more than 2 million bpd in year-on-year non-OPEC production growth in 2020, even as demand grows by only 1.2 million bpd. The OPEC secretariat’s official forecast is even more pessimistic. Despite the outlook, there is little appetite for a deeper cut to prevent the inventory rises that this situation may cause. Many believe that the official forecasts for growth are probably a bit too high on U.S. shale in particular due to the "capital starvation" inflicted on smaller producers by the reticence in the U.S. bond market to provide further debt financing. There also is some hope for a brighter demand picture if the United States and China agree to stop escalating tariff increases and roll back some of the recent ones, which could improve global economic growth next year and reduce the chances of a global recession. Even if the more positive scenarios for OPEC+ producers play out in both these cases, though, inventories would still build next year. 

Short-Circuiting the Cycle

A large additional production cut by OPEC+ could reverse some of the slowdown in U.S. shale growth, and it is now clear that this could lead to a cycle of repeated production cuts — essentially trading short-term financial gains for loss of future market share — that would not be revenue-positive for long. Russia, in particular, has been clear in recent months that while it will continue to "cooperate" on oil policy with the Saudis and OPEC, it will not let this sort of repetitive cycle play out. Russia is in a much more comfortable position than the Saudis when it comes to short-term oil prices, as its 2019 budget balances with the Russian benchmark Urals Blend at $49 per barrel, whereas the Saudis must contend with a large deficit and a budget-balancing price for 2019 estimated by the International Monetary Fund at $85 per barrel Brent. 

Russian oil industry titan Igor Sechin has opposed cooperation with OPEC all along, and while President Vladimir Putin overruled him three years ago, Sechin's views still matter. Putin has come around to the belief that while Russia should continue to coordinate, it should make clear that its views differ from those of the Saudis on prices. In June, right after the price slide began, Putin announced that Russia was happy with a range of Brent prices at $60 to $65 per barrel, underscoring that it would not consent to deeper cuts. All of this is driven by a desire to avoid supporting faster U.S. production growth while avoiding a price collapse by consenting to restrain Russian output growth.

The Saudis' Ineffective Lever

This leaves the Saudis in a weak position. Historically, Riyadh’s whip hand has been that it had the option of opening the spigots itself, as it did in 1985, and therefore could punish those who did not comply. With Crown Prince Mohammed bin Salman facing large deficits and trying to sell a small slice of Saudi Aramco at an inflated value, however, nobody else has to fear this scenario. While overall compliance with the production quotas appears high, not many of the OPEC and non-OPEC countries that are part of the deal actually have the capacity to increase production rapidly. Much of the non-OPEC agreement came from countries that could claim credit for natural declines and underinvestment as a result of lower prices, with Russia and Oman the only non-OPEC countries that actually altered their behavior.

Within OPEC, countries like Venezuela and Iran have seen sharp slides in production for other reasons that will not be reversed soon. Saudi Arabia, Kuwait and the United Arab Emirates are the only members of OPEC complying with cuts that also have spare capacity to activate on short notice. Both Nigeria and Iraq are well above their quotas and even their pre-cut production levels, acting as free riders while rhetorically supporting OPEC+.

The outcome will most likely be an extension of current production targets through at least June 2020, with a pledge of "strict compliance" by all touted as a cut of close to 500,000 bpd from current levels by eliminating cheating. Russia is likely to comply for at least a few months, especially when winter normally reduces Russian industry activity a bit. But Nigeria and Iraq are set on a path of investing in capacity growth and feel no need to do much beyond issue supportive statements. This may be slightly negative for prices, but in the short term, perceptions around U.S.-China trade negotiations will be a larger driver for the market.

Put in a broader perspective, it is clear that in relative terms, Russia has benefited from cooperating on oil production with the Saudis more than the kingdom has. With Russia having surged output during the brief period when individual quotas were removed in late 2018 and successfully demanding a new benchmark for the current quotas, as well as a smaller percentage cut, it has profited from the Saudi desire for higher prices without having to take much action. Saudi Arabia was down well over 1 million bpd from late-2016 levels before its current (and temporary) restocking from the Abqaiq disruption, while even if it weren’t cheating, Russia would still be above late-2016 levels. Putin has played this masterfully.

Editor's Note: Greg Priddy, who has recently joined Stratfor as director, global energy and Middle East, will focus his coverage on the space where geopolitics and the global energy industry meet, as well as contributing to broader regional and global macro analysis.