OPEC+ Output Increase Wins It Credit but a Realignment Awaits Beyond August

A worker at an oilfield owned by Russian state oil producer Bashneft in Bashkortostan. The EU has agreed to forbid Russian oil imports by the end of this year. Photo: Reuters

Russian Foreign Minister Sergey Lavrov visited his Saudi counterpart, Prince Faisal bin Farhan, on Wednesday, just ahead of the Opec+ meeting on Thursday. The direction of travel shows how the balance of power between the twin poles of the oil exporters’ organisation has shifted. Opec worked hard to bring in Russia in 2016 and keep it onboard in 2020 — now Moscow is the suppliant.

Mr Lavrov was not the kingdom’s only recent important visitor. Late last month, American energy envoy Amos Hochstein and Middle East point man Brett McGurk made a trip to discuss energy security. And US President Joe Biden now plans to visit Saudi Arabia next month.

On Tuesday, the EU agreed after long deliberation to bar Russian oil imports by the end of this year, other than pipeline supplies to landlocked central European countries. This will cut about 90 per cent of Russian supplies to Europe, 3 million barrels per day at the end of last year.

Russia will seek compensating markets in Turkey, India, China and other countries, challenging traditional markets for GCC and Iraqi oil. But how much it can sell here will be limited by logistics and market appetite, and the impact of a European ban on shipping insurance. Lack of access to finance and technology will see upstream output decline over time.

High prices, the progressive loss of Russian exports, the EU sanctions, and the concerns of major importers all suggest the world market needs more crude.

The Opec+ arrangement reached in the spring of 2020 and then adjusted in July last year put production cuts on schedule to be phased out by this September, although the accord remains in force until December.

The modified deal on Thursday accelerates production increases by half — in other words, the end of the cuts that had been planned after three months, in September, will now be achieved in August.

Moscow reportedly supported this measure. The Wall Street Journal had reported the idea that, like Venezuela, Libya and Iran, Russia’s participation in cuts could have been suspended, recognising its inability to commit to allowed levels.

Opec+ has faced a growing shortfall because of the inability of some members — mostly, Nigeria and Angola — to hit their production targets. Undersupply of 0.65 million bpd in November rose to 1.49 million bpd in March and then ballooned to 2.66 million bpd in April, according to the International Energy Agency, as Russian output slumped. The overall gap is equivalent to removing Kuwait from world oil supply.

In the early days of the Opec+ cuts, Russia consistently overproduced by a little. Now, its production is increasingly obscure, but S&P Global Platts estimated 9.14 million bpd in April, well below its 10.43 million bpd allowance.

By August, only Saudi Arabia and the UAE will have any significant spare capacity, totalling about 2 to 2.4 million bpd. Iraqi capacity might be creeping up. All other states will have hit maximum. This excludes, of course, the three members exempt from production targets, whose output is volatile and dependent on internal and external politics.

Allowing for this, the practical result of the accelerated schedule may be another 120,000 bpd on the market in July and 235,000 bpd in August. This is over and above the 800,000 bpd or so that would have been added between this month and September, again allowing for those members who are not able to reach their maximum allowable levels.

So after August, there will have to be a realignment of production targets, assuming they are not dropped.

Saudi Arabia and the UAE should have higher allocations and will want to defend their core Asian markets. The Gulf leaders are in a much stronger position versus Russia than in 2016 or 2020. Moscow needs the deal to hold together to keep prices high and the US and Europe in an uncomfortable position. Opec, for now, does not need Russia.

The output acceleration wins Opec+ credit.

The modest nature of the tweak, though, is indicative of its own mounting challenges.

The first, as described, is that it is running out of the ability to raise production.

The second is the limited worldwide capacity to refine its oil — particularly if Russian refineries are forced out of the market. A greater share of diesel-rich, medium-gravity Gulf crudes will help to some extent. But otherwise, the impact of further oil production increases is limited until mothballed refineries are revived and new facilities start up — a process Opec+ has no influence over.

And the third comes in the longer term: the continuing erosion of spare capacity. The UAE’s output capability should increase to 5 million bpd by 2030, or a gain of about 0.5 million bpd; Saudi Arabia to 13.4 million bpd by the beginning of 2027, up about 1 million bpd; and Iraq a scaled-back 6 million bpd by the end of 2027, a gain of 1.2 million bpd.

Unless Kuwait or Nigeria expand investment, or political changes free the troubled trio of Libya, Venezuela and Iran, there is no other prospect of major new capacity within Opec+ to replace what Russia will lose.

So as long as demand remains reasonably strong and there is no runaway growth from US shale, the question will grow of Opec’s relevance. For now, the visitor’s book in Riyadh is filling with illustrious names. But without the need to cut, or the ability to add, the organisation must redefine its mission.