Is OPEC+ losing influence over production and prices?

To:

Al-Monitor Pro Members

From:

Gerald Kepes

President, Competitive Energy Strategies, LLC

Date:

Jan. 17, 2023

Bottom Line:

Russia gave core OPEC+ members Saudi Arabia and the UAE unprecedented control over oil markets when it invaded Ukraine and was embargoed by the West. The United States has shown its discomfort with the leverage these countries have gained; the full results of these shifts in relative power will play out in the medium term. The longer term question is how China and India (the fastest growing consumers) will react to this concentration of market power

The next five plus years promise higher revenues for OPEC+ members, but the risks are extraordinary given an emerging, more fractured geopolitical environment. OPEC+ is likely to suffer in a deglobalizing world. It is a much more complex task to realize its objectives selling into a partitioned marketplace. Still, there are some positives for core OPEC+; Russia’s invasion of Ukraine in February 2022 was an enormous gift to Saudi Arabia and the UAE, because it allowed them tighter control of OPEC+ without the need to offer anything to Russia in return.  

Key characteristics of the medium term are likely to be higher oil prices and volatility. The core members of OPEC+ will generate higher but volatile revenues, with some production increases coming from a very limited number of producers. Overall OPEC+ is unable to significantly increase crude production in response to spiking, higher crude oil prices, including Russia, and so cannot act on behalf of global oil consumers. This version of OPEC+ will be much less useful to the world and will include China and India in due course.  

Background Facts:

Impact of the energy transition

  • The myriad effects of the energy transition superimposed on government policies, commerciality, service sector capacity and resource endowments means that perhaps 50-60 geologic basins globally are receiving significant investment. This is out of a total of 500 to 600 hydrocarbon-bearing basins with sufficient proven or potential hydrocarbons of interest.  
  • Outside of these 50-60 basins, several hundred other basins will see only modest or minimum investment. These other basins exist in a state of “subsistence exploration and production.” Production increases will be incremental where they occur, or basins will starve due to the lack of investment.
  • A number of highly attractive basins have serious above-ground risks discouraging investment from international companies despite favorable technical characteristics. Basins in Venezuela, Libya, Nigeria, Angola, Iraq, Iran and now Russia are notable examples. All have significant remaining potential but are constrained by policy, politics, instability or even war. These factors shape the list of 50-60 basins, pushing otherwise attractive basins into subsistence E&P.  These basins now comprise a substantial portion of OPEC+. 

The purpose of OPEC+

  • Saudi Arabia brought Russia into the cartel because it would be a means of influence over 11 million barrels per day (b/d) of crude oil production capacity, which competed with OPEC’s global oil market management.        
  • Announced in 2016, OPEC+ only really functioned from early 2020 to early 2022. The present trend places Russia more in need of the OPEC+ relationship than the converse; Russia now falls into the group of OPEC+ members who cannot increase production. 

The ones who can increase output

  • Saudi Arabia intends to raise its sustainable production capacity to 13 million b/d by 2027 (one million b/d higher than current). The UAE has announced that it will raise capacity from roughly 4 million b/d to 5 million b/d by 2027 also.       

The ones who want to but cannot

  • National oil companies in Iraq, Libya, Iran and elsewhere do have experienced personnel and capacity, but the global service sector and a level of experienced foreign investment is necessary to bring technology, capital and expertise to bear, assuming the political consensus exists and policies are altered to ensure that their basins stay within the “50-60 basins.”
  • The inability of most members of OPEC+ to produce to quota or with no quota is well known. The shortfall is impressive. Angola and Nigeria together are producing at over 600,000 b/d below quotaVenezuela may yield an additional 200,000 b/d in the coming months, but current output of roughly 700,000 b/d is as much as 2.5 million b/d below production levels achieved historically. Likewise, Libya’s current output of about 1.2 million b/d is 500,000 b/d short of what its oil sector has produced; it could see increases over the next several years but instability continues to plague the sector. Iran could supply 4 million b/d (and has done so) but output languishes at 2.6 million b/d due to sanctions and policy, roughly a 1.5 million b/d shortfall. In aggregate capacity for these five OPEC countries is 5 to 6 million b/d less than what it could be. The reasons are a mixture of common global factors with purely local drivers. Nonetheless, these shortfalls are unlikely to be remedied in the short term, or not consistently so, and it is not obvious that they will be addressed in the longer term. 
  • Congo, Equatorial Guinea and Gabon are producing at 80% of a combined quota of 650,000; resource maturity and lack of investment interest will drive further decline. 
  • Iraq, Kuwait and Algeria are producing at quota. Kuwait has had plans to increase capacity from 3 million b/d to 4 million b/d plus for 20 years but cannot summon the political consensus to execute. Iraq produces to a quota of 4.33 million b/d, and could potentially produce 6 million b/d plus, but the lack of political consensus, political violence, contractual structure and status of energy infrastructure continues to prevent it from achieving this potential.
  • Russia has now joined this group. Markets and sanctions aside, current Russian oil production of roughly 10 million b/d could attain 11 million b/d in theory, but beyond several years this becomes difficult. The ability of Russian companies to bring on new, greenfield projects offshore in the Arctic and the Sakhalin area is limited. Over time the lack of access to the global service sector, even if they have the same highly experienced Russian employees, will hurt capabilities of the Russian companies and service sector because technology and management of technology globally will continue to advance and benefit from the global experience pool, except for places like Russia where transfer will be hampered. As sanctions evolve, it will continue to make it harder to import into Russia higher technology gear whether software or hardware. There will be re-exporting and evasion, but the impact is negative. 
  • Less obvious is the brain drain from the Russian oil sector. Anecdotally, hundreds of thousands of younger Russians with experience in data science and data mining, quantitative analysis, the sciences and engineering have already left Russia. By way of example, much of the innovation in the onshore US unconventionals came from massive use of data mining tools on terabytes of subsurface and operational data.    
Alternative Scenarios:

Scenario 1: One scenario posits a global environment which is more permissive of higher investment in crude oil production across a number of hydrocarbon basins, within OPEC+ and without. Volatile and higher oil prices could delay the financial industries and other stakeholders’ focus on slowing hydrocarbon investment. Of course that same volatility has reinforced the political resolve to accelerate the energy transition and discourage investment in hydrocarbons.  This scenario appears to be lower probability, and the longer, lower investment in crude production proceeds, the more difficult it will be to generate significant new volumes.    

Scenario 2: Another scenario sees a lessening of the geopolitical tensions which have emerged between the “West,” and China and Russia, with other important actors pursuing independent strategies. But, the longer deglobalizing prevails, the deeper the re-wiring of economic and political infrastructure that is taking place. All of these factors disrupt and fracture energy markets and trade flows and are a hallmark of deglobalization.        

Conclusion - Most Likely Scenario:

In order to make the most of the energy transition, the OPEC+ cartel needs to control or influence a larger percentage of those basins with highly competitive cost structures and the ability to increase investment and output, or to constrain output when needed. Some of these objectives are failing with respect to most of the OPEC+ members. And now Russia is failing also.

A deglobalizing world fragments markets and favors traders and arbitrage, and disadvantages smaller less competitive producers who would be trapped in heavily discounted, niche markets. This marketplace is strongly disliked by larger exporting producers who dislike middlemen. 

The most likely or base scenario sees OPEC+ unable to increase production and lower prices in the 2020s, even should it want to. It cannot raise crude oil production significantly (not if it intends to maintain 1-2 million b/d of spare capacity). Its role as a guarantor of price stability will have expired

This scenario becomes destabilizing and intensely competitive when global crude demand declines, according to the energy transition's logic. Fewer basins receive significant investment. The price environment is still volatile but price weaknesses prevail as competition between OPEC+ members and other areas of advantaged production sharpens in order to secure markets and captive markets are challenged. The advantage invariably shifts to large energy consumers, those still purchasing large volumes of crude oil. 

Contributor Background:

Gerald Kepes has more than 35 years of experience as a consultant and petroleum geologist in the global energy industry. Most recently, he was vice president in energy & natural resources for IHS Markit, and previously, a PFC energy partner, where he established PFC’s global upstream consulting practice. He also held various positions with a US oil company in North Africa and the Middle East.

 

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