OPEC+ production scenarios for the start of another tumultuous year

On 2 December, the OPEC+ group of oil producers stuck by its production quota timetable, resolving to add a cumulative 400,000 barrels per day (bpd) of oil production in January.

Holding steady

OPEC+ – the Organization of Petroleum Exporting Countries (OPEC) states and ten others – took less than an hour on 2 December to confirm that it will stick with its timetable of monthly cumulative 400,000 bpd production hikes by producers within the group in the coming months, including January 2022. In a move not seen since 1986, OPEC+ has technically kept the decision of its 2 December session open-ended, meaning it could announce changes to its January production quotas at any time – particularly if it sees demand falling in line with the negative economic impact from the new Omicron COVID-19 variant. The decision was both pragmatic, given how little is known about Omicron’s likely impact, and beneficial to the group, in helping to put a floor under prices for the next month. The group is scheduled to meet again on 4 January 2022.

Behind the perfunctory 2 December meeting was a tumultuous period in oil markets and flurry of diplomatic activity between OPEC states and the US, particularly Saudi Arabia. Since peaking at more than USD 86 per barrel on 26 October, the international Brent crude benchmark fell steeply to USD 69 per barrel on the eve of the meeting, before rising above USD 70 following the threat of major US sanctions against the Russian energy sector in the event of Russian military action against Ukraine.

Market fears of an Omicron-induced plummet in oil demand will continue to suppress oil prices. Concerns about government restrictions in key consumer countries in response to the variant will continue to shape oil market sentiment in the coming weeks.

US intervention

Then there was the rhetoric from the administration of US President Joe Biden, and its decision on 23 November to release 50m barrels of crude from the US Strategic Petroleum Reserve (SPR) for purchase after weeks of lambasting OPEC for not pumping enough to meet resurgent demand.

The SPR release did little to immediately move markets but coincided with the Omicron discovery and profit-taking by oil traders early in October as the rally in crude prices showed signs of waning. Geopolitically, the timing of the discovery of Omicron can benefit both Biden and OPEC states, Saudi Arabia in particular as OPEC’s de-facto leader. Omicron’s discovery dented oil prices, relieving Riyadh of the burden of having to mollify Washington with more supply than OPEC+ had already planned to provide. The Biden administration welcomed OPEC+’s 2 December decision and has moved on to criticising domestic oil companies for allegedly failing to pass on lower oil prices at the pump.

The impact of the SPR releases are likely to be felt in January and February 2022, as at least 1m barrels per day (bpd) of oil becomes available in what – Omicron data depending – will be an already soft market.

The OPEC+ decision to signal that production increases will continue steadily is likely to help Saudi Arabia keep oil relations solid with Russia – the lynchpin relationship of OPEC+ that drives its considerable market power – as Moscow is more comfortable with lower prices than most OPEC producers due to its lower fiscal break-even.

Risk returns

For now, the autumn frenzy over high oil prices is over, as lower demand and supply risks return to the fore. As at the end of 2020, the oil market will end the year finely balanced. With COVID-19 still potentially stunting demand, international oil markets will remain highly fragmented. The data on the Omicron threat will be the predominant price driver in the coming weeks.

Although OPEC states do not overtly target a specific price, the USD 70 per barrel level will be a key consideration for group members, as it marks the rough tipping point of fiscal break-evens for the budgets of many producing states. For wealthier OPEC states, high oil prices have been a boon to economic recovery and financing massive energy transition and economic diversification plans; for the others, USD 70 oil is needed simply to avoid fiscal crises. Below USD 70 per barrel, any further US entreaties for more supply will likely be ignored.

Surging oil prices in the second half of 2021 helped OPEC and OPEC+ stay on a mostly even keel. This period of profit taking, and OPEC consolidation is likely at an end. Another bout of vexed decisions over market management is likely to take hold in the early months of 2022 as oil markets absorb extra supply and governments grapple with Omicron’s implications.

Updated scenarios

Saudi Arabia will continue to take the lead in OPEC+ to manage the competing demands of other large and influential producers such as Russia and consumer states. Keeping the 2 December decisions open demonstrates the kingdom’s willingness to flex OPEC’s protocols to cope with market uncertainty and remain the most proactive of the global large producers.

In May 2021, we set out three scenarios for how the oil market would play out for the rest of the year. We set out below our updated scenarios for the oil market in the first three months of 2022, identifying the key geopolitical drivers that are likely to shape markets and prices.

Most likely – Settling into USD 70

The Omicron variant is found to present increased contagion risk, but severe illness is restricted due to prior community transmission and vaccine deployments in most major oil consumer states. SPR purchases run at 1m bpd or less. Several OPEC+ producers – such as Nigeria and Russia – underproduce relative to quota, limiting the effect of December’s supply increase on oil prices. A standstill on US-Iran negotiations to re-enter the 2015 Joint Comprehensive Plan of Action (JCPOA – the nuclear deal) keep a lid on market expectations of Iranian oil exports. OPEC+ confirms its decision to add 400,000 bpd in January. The USD 70 price floor holds, but prices are unlikely to rise markedly beyond that level.

Credible alternative – Omicron the spoiler

The Omicron variant is found to present increased contagion risk and significant public health risks due to breakthrough infections and healthcare system stress. Governments in consumer states modestly reduce travel limitations but tighten restrictions on day-to-day life. This crimps oil demand going into late December, and oil demand trends downward through the end of February 2022. Progress in JCPOA talks remains limited, but the slow rapprochement between Iran and its Gulf Arab neighbours and a lack of sanctions enforcement curtail security risks that would add a risk premium to prices. Oil prices slide below USD 70. OPEC+ suspends the planned output increases for January and February. The move leads to moderate tensions between Saudi Arabia and Russia – and to a lesser extent, Saudi Arabia and the UAE – but OPEC+ cohesion holds.

Outlier: Geopolitics drive prices up

The Omicron variant is found to be moderately more transmissible than the Delta variant but presents materially lower threats of severe illness. Governments do not maintain the tighter pandemic control measures that were initially implemented. Inflation concerns ease at major central banks, preventing restrictive changes in monetary policy. Tensions between Russia and Ukraine escalate and the potential for US sanctions on Russian energy drives oil prices higher. JCPOA talks break down, sparking an increase in threats to energy and maritime assets in the Middle East. China restricts purchases of Iranian crude to pressure Tehran to re-join the JCPOA. Oil prices resurge toward USD 85. OPEC+ confirms its decision to add 400,000 bpd in January and February, but its credibility is weakened due to underproduction from several member states. The US again puts pressure on Riyadh to abandon OPEC+ restraints and raises threats of a further SPR release and adverse measures against OPEC, partly to manage resurgent oil prices, partly to isolate Russia.