OPEC Reaches an Agreement over Oil Dropping Amid Fears of Oversupply

OPEC Agreement over Oil Fears of Oversupply

Fri Sep 03 2021 07:28
Crude oil prices have reduced by 2% after the major oil producers arrived at a compromise regarding supply and statistics indicated that demand had slacked off in the early weeks of July 2021. 

Crude prices had increased drastically to highs that have not been seen in over three years but have since reduced significantly due to a pickup of supply. Brent crude went down to $1.73 per barrel, or 2.3%, at $75 a barrel. West Texas Intermediate (WTI) settled down to an oil slide of $2.1, or 2.8%, at $74 per barrel. 

The premium of Brent crude to WTI futures widened to the highest since July 2021 and the US benchmark went down precipitously because of demand concerns. The oil dropping initially began after the United Arab Emirates (UAE) and Saudi Arabia agreed to a compromise that will unlock an OPEC+ deal to improve global oil production as countries try to recover from the coronavirus pandemic. 

OPEC & Allies Agree to Increase Oil Production

The Organization of the Petroleum Exporting Countries and oil producers led by Russia have agreed to unleash millions of bottled-up crude in the next two years, offering to restore the cuts they experienced at the beginning of the coronavirus pandemic as economies and crude demand recover. 

Anticipating the return to pre-pandemic demand for oil and the uncertain full economic recovery, the group decided to gradually move, agreeing to monthly instalments of new crude oil until the end of 2022. This has resulted in oil dropping.

The agreement means that the oil cartels will increase oil output by 400,000 barrels per day every month from August, continuing until the revival of the entire halted oil output. Also, the deal will offer higher baselines to the UAE and four other countries against which their oil production cuts will be measured effective May 2022.

Furthermore, this move demonstrates the push-pull of the world on its over-reliance on fossil fuels. Although the US and Europe have designed ambitious plans to get rid of carbon-emitting fuels such as oil, the world is still hugely dependent on the supplies of those fuels including oil.

The 19th ministerial meeting of OPEC and non-OPEC indicated that oil demand worldwide had shown clear signs of improvement and the stocks of OECD were falling. This is because economic recovery resumed in many parts of the world thanks to the revamped vaccination campaigns. 

Brent crude has increased by 43% year-to-date and has increased by over 60% from this time last year. Many forecasters are predicting oil trading at about $80 per barrel during the second half of 2021.

Oil Production Cuts to End by September 2022

This agreement came after an unprecedented gridlock that started in the early weeks of July 2021 which saw Abu Dhabi reject an oil production plan that was coordinated for the group and led by its kingpin, Saudi Arabia. 

Although the organization has experienced disagreements before, this was the first public rift between Saudi Arabia and Abu Dhabi, which are close allies.

Abu Dhabi was demanding that its crude production "baseline" – the maximum volume of oil that is recognized as being able to produce by OPEC – be increased to 3.8 million barrels per day.

This figure would then be used to determine the size of the production quotas and cuts that it must follow according to the output agreements of the group. Members of the group cut the same percentage from their output baseline and therefore, having a greater baseline would allow the United Arab Emirates a higher production quota.

The agreement showed baseline increases for 4 OPEC member states and 1 non-OPEC member state starting from May 2022 namely:
  • • UAE
  • • Saudi Arabia
  • • Kuwait
  • • Iraq
  • • Russia
Russia is not a member of OPEC but is a leader of OPEC+. The oil production baseline for UAE will be increased from 3.1 million barrels a day to 3.5 million barrels a day. 

However, this figure is still short of the 3.8 million that was initially requested. The oil output baseline for Saudi Arabia will be raised from 11 million barrels a day to 11.5 million barrels a day. This deal was agreed to and supported by Abu Dhabi.

Supply Squeeze

The truce between Riyadh and Abu Dhabi who are long-time allies will help to ease the looming supply squeeze and mitigate the risk of an inflationary price spike. 

More so, it ends the diplomatic spat that scared traders because the conflict between the two allies risked untying the broader accord that would help to underpin the recovery of crude oil prices.

The multifaceted agreement is significant to the oil market. It provides consumers with a clear view of how fast the OPEC+ will restore the 5.8 million barrels per day of oil production that it is still withholding after making considerable cuts in 2020 in the first stages of the coronavirus pandemic.

The agreement also serves to resolve the longstanding grievances that had resulted in tensions within the OPEC+ in late 2020.

Abu Dhabi had declined an agreement in early June 2021 claiming that the manner in which its quota had been calculated was unfair as it did not reflect the costly expansion that the country had made in its oil industry. Once they had agreed to a successful deal, both countries stressed the friendliness and strength of their relationship.

Key Facts from the Agreement

  • UAE and Saudi Arabia were involved in an unusually public conflict that threatened the unity of the oil cartel. The dispute was resolved with a classic compromise – Riyadh met Abu Dhabi halfway in the proposed demand for a much generous limit of oil output. After a fortnight of fraught discussions, they agreed to boost oil production by 400,000 barrels per day beginning in September every month until they resume operating at pre-pandemic levels.
  • After production cuts of about 10 million barrels a day in 2020, oil producers are still producing 5.8 million barrels per day fewer than before the coronavirus pandemic. This means that the agreement would bring oil output to pre-pandemic capacity by September 2020. The group plans to reassess its decision in December this year.
  • This decision was arrived at after oil producers from UAE stalled an agreement because it extended oil output limits through 2022, something producers from Saudi Arabia believed was crucial in preventing the supply of excess oil which could tank prices. In the agreement, Saudi Arabia agreed to increase those production limits.
  • Trading at about $72 a barrel in July, the barrel price of West Texas Intermediate has reduced by nearly 5% after the UAE and Saudi Arabia came to their agreement. However, they are still at their highest point since September 2018.

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