OPEC+ to Cut Production, but Should Heed Energy Market Shifts

Saudi Arabia and the other Gulf Cooperation Council states have, rightly, always prioritized their national interests when making decisions on oil output. They find it arrogant for the United States to expect them to act as its petroleum ATM. Yet in the latest spat, they have to beware that the energy market has changed in three key ways.

On October 5, in Vienna, the OPEC+ group of OPEC and non-OPEC oil producers decided on a larger-than-expected cut in production targets – 2 million barrels per day – in the face of strenuous U.S. lobbying and counterproposals. The White House responded furiously with Saudi Arabia in the firing line, complaining that the decision favored Russia – the other leading member of OPEC+ – in its war with Ukraine and threatened the health of the world economy. Prices at current levels are not exceptional by historic standards, and not sufficient on their own to explain the United States’ outraged response. They have actually dropped back since the meeting.

The actual cuts will be less than what was announced, as several members had been falling short of their allowable levels. Bloomberg calculations suggest the real reduction may be closer to 900,000 b/d, and Saudi Energy Minister Prince Abdulaziz bin Salman said 1 mb/d to 1.1 mb/d. Still, the economic necessity is arguable. Prices had dropped from almost $124 per barrel in June to $84/bbl in the run-up to the meeting – otherwise, there would have been no cut.

The world economy is shaky, but there are not many clear signs of demand destruction. China will at some point have to begin relaxing its coronavirus-induced lockdowns, possibly after China’s Communist Party National Congress ends on October 22. OPEC+ could have waited to see how effective the European ban on Russian oil will be when it comes into force on December 5. Tightening supply now risks pushing up inflation, accelerating interest rate rises, and slowing down the world economy and, consequently, oil consumption.

Amin Nasser, Saudi Aramco CEO, warned that global spare capacity was still “extremely low.” The cuts increase spare capacity but at the cost of drawing down inventories, the oil market’s other shock absorber. Saudi officials reportedly told a U.S. delegation that if the United States thought the market needed more oil, it should produce it itself.

The big shortfall in world supply, though, is from OPEC+’s own members. OPEC was nearly 1.4 mb/d below its goals in September, and the non-OPEC states were 2.2 mb/d below their quotes, with 1.3 mb/d of that shortfall attributable to Russia. Saudi Arabia itself is set to increase capacity by a mere 1 mb/d by 2027; only the UAE of all other participants has significant, credible expansion plans.

This is far from the first time that OPEC, and specifically Saudi Arabia, has disagreed with the United States on oil production. Apart from the 1973-74 embargo by a group of Arab oil exporters, Riyadh increased output only cautiously in May 2008 as prices were soaring, despite entreaties from then-President George W. Bush. The group can, and does, get the market wrong, often erring on the side of higher prices. But there is almost always an economic logic to its position; it is not necessary to invoke politics. Conversely, the political side – meaning U.S. domestic affairs – has been paramount in the appeals of successive administrations since the presidency of Richard Nixon, usually for lower prices, sometimes for higher.

Though the decisions are not mainly politically motivated, they have crucial political implications. Saudi Arabia has several times raised output to head off supply disruptions from Iran, Iraq, Libya, and Venezuela, all of them OPEC members. In all of these cases, its approach was helpful to U.S. policy. And at least in the cases of the 1986 oil price crash during the Iran-Iraq War, Saddam Hussein’s 1990-91 invasion of Kuwait, and the sanctions on Iran from 2012-15 and since 2018, Saudi actions have been detrimental to its supposed colleagues. But Riyadh has to be even more careful now because of three key energy market shifts.

The first shift has been the end of the U.S. shale revolution. U.S. oil production should continue to grow. But it faces supply chain constraints, investor caution, and U.S. shale oil corporations’ dislike of the administration of President Joseph R. Biden Jr.’s anti-fossil fuel policies, even if these have not had much practical impact. The United States is no longer able, as it was for the decade after 2010, to satisfy all global demand growth and to crash the market.

OPEC+ was formed precisely because OPEC realized it could not take on U.S. shale on its own; it needed Russia and other allies to avoid conceding market share. That rationale is now past, but OPEC+ endures. Indeed, with about 52% of world oil production, it is more dominant than OPEC at its 1973-74 peak, which reached 50%.

Second has been the Russia-Ukraine war and the general move to more confrontational international politics, particularly regarding Western policies toward China. The oil market rationale of inviting Moscow to Vienna was clear. But bringing into OPEC+ a disruptive, nuclear-armed great power with globe-spanning ambitions is a very different matter to incorporating Brunei or Congo.

If OPEC+ becomes seen again as an anti-Western campaigner rather than a constructive force for stability, customers will find ways to counter it. The United States and European Union plan to bring in a cap on the price of Russian oil exports to deny Russian President Vladimir Putin revenue. There is some disquiet within OPEC that such a mechanism, once created, could be turned against them. After all, sanctions on Iran’s and Venezuela’s oil industries have steadily tightened.

The GCC states have tried to maintain their pro-Western alignment, while China becomes their key energy customer and trading partner and Russia a helpful diplomatic and military counterweight. But even Beijing cannot be happy with high prices being dictated between Riyadh and Moscow. That balancing act has just become much harder.

Gulf states complain of U.S. inattention to their security, while U.S. lawmakers threaten to cut off military support. Whatever their dislike for the Biden administration and its attempts to revive the Iranian nuclear deal, it was Donald J. Trump who as president said he was in “no rush” to intervene after the September 2019 missile and drone attacks widely attributed to Iran on the crucial Abqaiq and Khurais oil facilities in Saudi Arabia’s Eastern Province. If a serious Iranian threat to Gulf oil or gas exports materializes, in this already critical energy situation, the United States would clearly intervene. But it would no doubt set conditions.

The third has been the long-term issue of climate change. The United States often warns OPEC that lower production will damage the world economy and demand for its product. The 1973-74 and 1978-80 crises led to permanent destruction of oil consumption and advances in competing producers, energy efficiency, and non-oil technologies. Since then, OPEC has been more cautious about very high prices. But it has usually been sanguine about moderately elevated prices, even when these have contributed to economic downturns, concluding that eventually demand will recover.

Now is different. Oil consumers have viable alternatives, particularly in increasingly popular and capable electric vehicles and the emergence of hydrogen. While energy security and the desire to get off Russian hydrocarbons will temporarily boost demand for alternative supplies of oil, gas, and coal, policies such as Europe’s REPowerEU and the United States’ Inflation Reduction Act will drive the deployment of low-carbon technologies and create political constituencies for them.

Beyond being an oil production management system, OPEC should think about its longer-term role in a climate-conscious world. The organization has already been through several incarnations: In its first decade beginning in 1960, it sought a fairer share of taxes, then turned its attention to raising prices. Only in 1982 did it introduce quotas, the role for which it is now best known. The OPEC+ alliance, another transformation, came in 2016.

OPEC’s oil market management could be more nuanced than the blunt instrument of quotas. Already that has softened post-pandemic, with monthly Zoom meetings to adjust output instead of less frequent in-person events. The organization could entertain the United States’ suggestion of refilling its Strategic Petroleum Reserve when prices fall below a certain level: $75 per barrel for Brent crude, according to The Wall Street Journal. The Strategic Petroleum Reserve has been drained to its lowest level since 1984 as Biden battles inflation and high gasoline prices; a promise to restock it would put a floor under prices and encourage investment in future supply.

If OPEC were to recast its mission as assisting its members in energy transition and economic diversification, it might attract less opprobrium. Saudi Arabia and the United Arab Emirates, and non-OPEC Oman and Bahrain, already have net-zero carbon targets. Making climate progress and avoiding a repeat of the current energy crisis should provide common ground for the United States, Europe, and OPEC and help avoid a further breakdown of relations.

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