OPEC+ scenarios – Slow return of output amid fragmented COVID recovery

The OPEC+ group of oil producers – the Organization of Petroleum Exporting Countries (OPEC) states and ten others – has started to reverse oil production cuts in expectation of a return to strong oil demand. To aid strategic planning for oil producers and consumers, we have set out three scenarios for the trajectory of the oil market this year.

• OPEC+ will return 2m barrels per day (bpd) to global markets by the end of July, a sign of confidence that restrictive market management is no longer required.
• However, the global recovery from the COVID-19 pandemic is likely to remain highly fragmented and fragile, with major downside risks to oil demand in the rest of 2021.
• Each scenario considers a broad range of pandemic-related factors, underscoring how the oil market will remain volatile until 2022.

• Our most likely scenario sees OPEC+ return to more active supply management after July as mixed pandemic outcomes imperil the global recovery in oil demand.
• Our credible alternative scenario sees oil demand surge under accelerated deployment of vaccines, increased air travel and an absence of major outbreaks in oil consuming countries.
• Our outlier scenario sees OPEC+ cohesion buckle under poor pandemic outcomes and the return of non-OPEC+ supplies into a tepid oil market.

High hopes for summer

With pandemic restrictions easing in several major Western countries and the summer holidays in the northern hemisphere, governments and oil producers are hopeful of a bumper season for oil demand.

On 1 April, OPEC+ confirmed a steady course of production increases for May to July based on a sunny outlook for oil demand. Together, the group will add 2m bpd of supply by the end of July, putting 25% of the oil they had been keeping shut-in back onto the market. Oil prices have modestly risen since, suggesting that a break from the intensive crisis management of 2020 may be well timed.

Clouds on the horizon

While there are legitimate reasons for cautious optimism in the medium-term, the rest of 2021 is likely to be characterised by high volatility for the oil market. Significant risks for the key oil producers and the most vulnerable oil-exporting states will persist. The ongoing fragility and asymmetry in the global appetite for fuels will complicate recovery planning.

Below, we break out three potential trajectories for the oil market until the end of 2021 arising from the pandemic and assess the challenges these will pose to OPEC+’s efforts at market management, as well as their implications for key producers.

In all three of our scenarios, OPEC+ – and Saudi Arabia in particular, as the group’s de facto leader – is likely to find oil market management for the rest of the year more challenging than the first half of the year. The group’s cohesion and compliance with its own targets will be tested by an uneven recovery over the next seven months, in which major uncertainties over both the demand and supply sides of the oil market will persist. Geopolitics will remain of primary importance, not least between the major OPEC+ oil exporting states – Saudi Arabia, the UAE, Iraq, Russia – for whom securing long-term market share in Asia is a strategic priority.

Market drivers

For each of these scenarios, several drivers will continue to shape oil supply and demand throughout the rest of 2021:

• Travel restrictions and economic recovery in the advanced economies will vary significantly between different regions. New virus variants may trigger surges in cases in the second half of the year. Full reopening in advanced economies will not take place before 2022.
• Emerging markets (EM) recovery remains even more uneven with several major consumers like India, Turkey and South-East Asian countries registering an increasing number of COVID-19 cases and introducing new restrictions. Several major non-OPEC+ oil suppliers – like Brazil and Colombia – will continue to experience high levels of infections in the coming months. With vaccination rates among most EMs lagging significantly behind their G7 peers, economic recovery will remain fragmented.
• Global mobility trends will remain uneven and subject to rapid change. Domestic mobility within some advanced economies – like the UK and US – has been on a steep rise, fuelling a return to pre-pandemic levels of gasoline and diesel demand. International travel may see a temporary surge during the northern hemisphere summer – and this will rely on pandemic management going to plan in dozens of countries in North America and the EU – but it is much less clear if a sustained recovery will follow. Recovery in long haul commercial transport is likely to be gradual as supply chain dislocation continues and pandemic disruption persists in some regions.
• While under our most likely scenario for the US-Iran nuclear negotiations, unsanctioned oil exports will not begin until 2022, Iran has expanded its sanctions-evading oil exports, primarily to China. These exports could increase further in the coming months, boosting unregulated oil supply to a key customer for several OPEC producers.
• But any escalation of US-China tensions or new major security incidents in Middle East could drive oil prices higher and lead to temporary supply disruptions.
• Compliance fatigue is starting to set in within OPEC+ as some more vulnerable suppliers seek to capitalise on higher prices and strong demand in China with greater export volumes. OPEC+ members with a history of poor compliance are unlikely to “repay” their dues in 2021 – leading to a high supply outlook.
• US shale sector and US oil inventories remain an important consideration. Glutted with easy capital over the prior decade, US shale is now starved of it, but US progress with vaccinations and a positive growth outlook could accelerate US oil production and exports. A recovery in US shale would bring the need to defend market share back into consideration for OPEC+ members – especially Saudi Arabia and Russia.
• The pandemic has brought new urgency to the energy transition in terms of both new prospective climate legislation and targets in major consumer markets, activist pressure, and capital flows away from traditional oil and gas activity and toward hydrogen and renewables. The acceleration of these trends, already firmly under way, will impact the scale of new investment in oil projects, potentially setting the scene for a shortage of oil supply in the years to follow.

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Scenarios for OPEC+

Most likely – Continued coordination
Under this scenario, spikes in COVID-19 cases in strategic middle-income markets such as Brazil and India destabilise the global oil demand recovery, creating challenges to OPEC market management and keeping Brent benchmark oil prices around USD 65-USD 70 per barrel. India takes several months to suppress record COVID-19 case rates with limited lockdowns as vaccine deployment remains challenged. India’s refiners moderately cut back on purchases due to reduced domestic demand. Nuclear deal negotiations between the US and Iran progress but implementation does not begin until 2022, keeping a lid on Iran’s oil exports at current rates. Slow shale output recovery keeps US domestic oil stocks lower amid recovering demand for travel fuels.

OPEC+ gradually tapers production cuts as planned, leaving the majority of global spare oil production capacity in Saudi Arabia. Oil inventories remain broadly flat, with global supply and demand finely balanced. To avoid another rise in global oil stocks, OPEC+ resumes monthly decision-making after July to determine whether to keep tapering production cuts, hold them in place, or even make new cutbacks. Lower fiscal break-evens for Gulf producers incentivise a modestly more accommodative oil policy, bringing them more into line with Russia. Moscow in turn accepts ongoing market management for the rest of the year. While each monthly OPEC+ meeting features tensions between producers, cohesion and compliance hold.

Credible alternative – Tapering takes off
India’s COVID-19 wave is contained and not replicated elsewhere. The US, UK and EU agree to suspend vaccine patents and ease vaccine manufacturing supply chain bottlenecks to quickly increase global vaccine supplies. Vaccine supply bottlenecks ease, allowing states to reach inoculation rates that facilitate further re-opening of travel. Passenger aviation sees a mini-boom due to pent up demand for leisure and business travel, facilitated by functioning “vaccine passport” systems. In several major oil consumer states or regions (Japan, Brazil, India, Europe) gasoline and diesel demand steeply return to pre-pandemic levels. Iran-US nuclear deal talks stall or fail. Libyan oil exports are constrained by a faltering reconciliation process and sporadic threats to oil fields. Oil prices surge above USD 70 per barrel on the back of supply concerns.

With prices rising, most OPEC+ states – including Iraq, the UAE and Russia – push to taper production cuts sharply for the second half of the year into a strengthening market. Saudi Arabia agrees to reopen the taps and successfully position itself as the group’s sole swing producer.

Outlier – Under long COVID, cracks appear
Vaccine supply and hesitancy problems, combined with new threats from highly contagious COVID-19 variants – keep major customers in a doom loop of outbreaks and pandemic restrictions. New variants prove resistant to some existing non-mRNA-based vaccines. Global co-operation on vaccine deployment remains low, depriving major middle-income states of the ability to further relax restrictions. US-Iran talks reach an agreement in principle over nuclear deal re-entry by the end of August, and implementation begins shortly after, raising the prospect of up to 1m bpd of oil exports being added to global supplies in early 2022. Political reconciliation in Libya allows for unconstrained exports. Oil prices start falling back toward USD 50-USD 55 per barrel. These Iranian and Libyan supplies – outside OPEC+ control – increase pressure on OPEC+ to sustain longer production constraints to compensate.

The oil futures market signals that global oil stocks will rise, prompting Saudi Arabia to lobby OPEC+ members to row back the summer production increases. These members, including the UAE, Russia and Iraq, object to the prospect of another year or so of production restraint. While OPEC+ does not break up, the ability of the group to reach consensus breaks down. Under severe Zoom fatigue, ministerial meetings are reduced to quarterly intervals. Compliance by peripheral non-OPEC OPEC+ members buckles and both the UAE and Russia openly question the usefulness of the group. Attempts to rebalance the market increasingly rely on Saudi Arabia alone.