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What's Behind Opec-Plus Olive Branch Policy Move?

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Opec-plus surprised many people this week by shifting gears and accelerating the unwinding of its 2020 production cuts by one month. The move won't add much supply to the market because many members of the alliance have been struggling to meet their production targets. But it does extend an olive branch to consumer nations, which have been expressing alarm about sky-high oil prices.

During a meeting on Thursday that lasted just 11 minutes, Opec-plus agreed to increase its combined output by 648,000 barrels per day in both July and August — up from the previously agreed monthly increments of 432,000 b/d. Energy Intelligence understands that before the meeting, high-level coordination took place between Saudi Arabia and other members of the alliance to ensure there would be unanimous support for the change of plan. After the announcement, the White House praised the efforts of the kingdom and other Gulf allies.

Below, we explore some of the key questions about Opec-plus' decision to diverge from its previously agreed playbook in the final few months of a supply management scheme that has been in place for more than two years:

 Why did Opec-plus decide to speed things up now?

Fear of demand destruction during the summer — when oil consumption typically peaks — was one of the key factors that led the alliance to change course. During Thursday's brief ministerial meeting, it was noted that refineries are also coming out of maintenance and need additional crude, according to one delegate. Producer countries were also keen to avoid a repeat of the 2008 scenario, when high oil prices were followed by an economic recession. Although Opec-plus cannot prevent a global recession, the promise of additional supply may at least relieve some of the upward pressure on oil prices.

Opec's in-house estimates indicated that more supply was needed to offset a tight market and rein in prices, which had risen above $120 per barrel earlier in the week after the EU agreed to ban oil imports from Russia. Global crude inventories have been rising, but all three of Opec's scenarios show inventories remaining below the pre-pandemic average for 2015-19 for most of this year. Only its low-demand scenario shows stocks returning to the 2015-19 average — and not until December.

Thursday's decision was also seen as a gesture by Gulf states toward the US ahead of a possible visit by President Joe Biden to Riyadh later this month.

But heavyweight Gulf producers were also keen to maintain unity within Opec-plus and avoid the appearance of knee-jerk acquiescence to consumer nations' demands for more oil. That's why the alliance waited until market conditions fully warranted an adjustment of the previously agreed plan, Gulf delegates said.

What impact did the decision have on oil markets?

Brent crude prices fell slightly on Thursday but picked up again on Friday to trade around the $120 mark — down a few dollars from levels reached earlier in the week. The new agreement won't add much supply in practice, but it may help psychologically by showing that Opec-plus is willing to act and by pointing out a path to higher output.

Under the revised plans, Saudi Arabia will produce an additional 57,000 b/d and the United Arab Emirates an additional 18,000 b/d in both July and August. But many other members have been unable to hit their production targets and are likely to fall short again over the next few months. Energy Intelligence estimates that April production for the entire Opec-plus alliance came in at 2.6 million b/d below the pledged level.

For the time being, steep price discounts have helped Russia — a key member of the Opec-plus alliance — maintain its crude oil exports at around the same levels seen before its February invasion of Ukraine. However, its exports of refined products have fallen by around 600,000 b/d from prewar levels.

Much of the upward pressure on oil prices has come from the markets for refined products, and those are not directly affected by Opec-plus supply management efforts, which are entirely focused on crude. Some refiners believe that only demand destruction — consumers buying less fuel because of its high cost — will bring prices back to earth.

Why is the Opec-plus move significant?

The light tweak of the alliance's existing plan will not do much to boost supply in the short term. But it does show a willingness on the part of some members to think about raising production. There is a growing expectation among consumer states that Saudi Arabia and the UAE will continue to raise their output further down the line, or at least make up for the shortfalls of other Opec-plus members. So far, however, they have not signaled any intention to do so.

The revision of the plan was backed by all Opec-plus members, including Russia, despite its struggles with sanctions imposed by the US, the EU and other countries. Saudi Arabia, in particular, has been striving to maintain good relations with Russia and make sure it stays in the alliance, while also improving strained relations with the US. The decision reached on Thursday reflects that delicate balancing act. On the one hand, it offers a modest gesture to the Biden administration ahead of midterm elections in November. And on the other, it keeps Moscow within the Opec-plus fold.

What comes next?

The next Opec-plus meeting is scheduled for Jun. 30. Over the next two months, members of the alliance will continue to monitor the market as they complete the unwinding of the deep production cuts made in 2020. It's unclear what the alliance will decide to do after August. The key issue is whether there will be a major restructuring of the production quota system to address the difficulties that some members had in hitting their targets. For the leadership of Opec-plus, a top priority is to maintain unity within the alliance and extend cooperation among the members beyond this year — particularly in regard to the continued participation of Russia.

Topics:
Oil Supply, Opec/Opec-Plus, Policy and Regulation
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