Oil market dynamics are changing

The recent OPEC+ decision to not freeze production growth was a sign that oil producers are increasingly being forced to listen to consumers.

An important reason behind the decision by OPEC+ to not freeze production quotas was its fear of angering the main oil importing countries, writes Kozhanov [Dado Ruvic/Illustration/Reuters]

Earlier this month, the Organization of the Petroleum Exporting Countries (OPEC) and its allies, a grouping known as OPEC+, announced their decision to stick with their planned output increase of 400,000 barrels a day in January.

The grouping’s decision came at a time of heightened concern for producers and consumers and shone a spotlight on the new realities and changing dynamics of global hydrocarbon markets.

On December 2, OPEC+ countries came together at a virtual meeting to decide between two scenarios: continuing to increase their production volume or temporarily freezing it.

On the surface, there were many strong motivations for them to opt for the latter option: the expected oversupply in the first half of 2022; the fear that a new strain of coronavirus could further reduce the rate of oil consumption; and the decision by the United States and a number of other countries, including India, China, Japan and South Korea, to release large volumes of oil from their strategic reserves to the market to reduce prices. However, despite hearing strong arguments for a freeze, the cartel decided to hold the line on its current output plan.

There were multiple reasons behind the cartel’s decision:

First, the current economic development strategies of the key OPEC+ players (and, especially Gulf monarchies) make freezing (or reducing) production quotas an undesirable scenario. In the long run, global oil demand is expected to decline, seriously reducing the incomes of oil exporters and turning some of their oil fields into stranded assets. To avoid this, producers are working to diversify their economies and to make renewable energy a viable part of their economic structures. For now, the only viable source of funding OPEC+ countries have for their diversification efforts is their oil resources, and they are under increasing pressure to turn these resources into cash before the predicted decline in demand and fall in prices devalue them. This means, for OPEC+ countries, the self-imposed output limitations can be nothing more than temporary measures to stabilise the oil market and delay the fall in prices – in the long run, it will always be more beneficial for oil producers to increase production volumes.

Second, the volume of the predicted market oversupply in 2022 remains unclear. Indeed, there is no unanimity among experts on the longer-term prospects of the oil market. While many expect the market to be significantly oversupplied, encouraging greater competition between the players, others warn that continued underinvestment in the oil sector can result in producers significantly failing to meet the demand. This means OPEC+ members are somewhat blindly walking through a minefield, and trying to avoid making wrong choices which could result in significant loss of income and halt their efforts to adjust their economies to new post-hydrocarbon realities. Thus, they are reluctant to reduce production volumes, but they are also not willing to increase them beyond the already established quotas, so as not to bring down oil prices, especially since any period of shortage can easily be followed by a period of overproduction.

Third, OPEC+ members know that even if they commit to holding the line on their current output plan, they may still fail to reach their production quotas. By November 2021, the difference between the nominal production quota and real production in OPEC countries was -390,000 barrels per day. Moreover, under the pretext of respecting each other’s production quotas and interests, they refuse to make up for the volumes under-produced by other member states. This has its own logic: under-production supports higher prices which is especially important on the eve of the expected glut of the market in 2022. It also allows producers to limit their cartel’s production volumes without aggravating consumers.

Consumer power on the rise

Another important reason behind the decision by OPEC+ to not freeze production quotas was its fear of angering the main oil-importing countries. These days, oil consumers are gradually increasing their influence over the market. With the progress of energy transition and the expected return of frequent market oversupply, it is increasingly demand, not supply, that is determining the dynamics of oil and gas prices.

An excess of oil on the market is already expected in 2022 and according to some estimates, by 2030, there may be up to 10 million excess barrels per day on the market. Attempts by producers to exert pressure on price changes by regulating production volumes are thus increasingly being met with sharp reactions from consumers. But at the same time, expectations of oversupply and high levels of uncertainty in the market are providing producers with certain levers of influence.

This change in the power dynamic between producers and consumers already had a significant consequence. On November 23, US President Joe Biden ordered 50 million barrels of oil to be released from the US strategic reserve to help bring down energy costs. This move was important for multiple reasons.

First of all, with this move, the US openly reclassified itself as not a producer, but a consumer of oil – and it made clear that it is not happy with high prices and limited supply. Of course, the US government has long been influential in determining what happens on the oil market. Since the mid-2010s (if not earlier), however, it was perceived to a greater extent as a producer, not a consumer. Indeed, even when Biden’s predecessor, former President Donald Trump, expressed dissatisfaction with moves by OPEC+ to tighten production quotas or criticised the cartel’s short-lived price war of 2020, the OPEC+ countries continued to perceive the US primarily as an oil producer.

The US started to act more like a consumer than a producer for the first time earlier this year, when despite the increase in prices, its domestic shale producers abandoned their policy of pumping out as much oil as possible in favour of a more restrained approach to production growth. The current administration tried its best to encourage greater growth in domestic shale oil production but failed to change the minds of producers. By deciding to release significant reserves to decrease prices, the Biden administration showed in clear terms that it is supporting the domestic industry’s new stance and that it is now ready to act as a defender of consumer interests.

What made Biden’s decision to release reserves even more significant was the fact that it was supported by several other global powers. Despite existing political tensions, the US was able to unite a group of influential oil consumers who have long been struggling on their own against OPEC+’s production limitations and consequent price hikes. China, for example, sold off part of its own resets in the autumn of this year, and India, Japan and South Korea also recently voiced similar intentions. None of these Asian countries had used their oil reserves for such a global and coordinated price war in the past.

Not a war – yet

Of course, Biden’s decision on November 23 was not an outright declaration of war, but a demonstration of consumers’ new gained capacity to affect the market. In terms of its scale, the total volume of oil planned to be released from reserves does not exceed the global daily demand (however, in order to balance it, OPEC+ would still need to abandon increasing production quotas for some time). Moreover, the release of extra barrels will be staggered, and a significant part of them should be returned by sellers to the US reserve. There are also still some questions over the commitment of US’s Asian partners to releasing their reserves (So far, only Japan fully confirmed that it will make the move).

Nevertheless, for OPEC members, and especially for Gulf monarchies, the warning issued by their Asian consumers was significant. Considering the primary role Asia is expected to play in the future of the oil market, having long-term positive relations with Asian powerhouses will likely be key to Saudi Arabia, the United Arab Emirates, Iraq, Kuwait and, potentially, Iran’s ability to maintain their positions in the oil market during this unstable period of the energy transition.

As a result of all this, on December 2, OPEC+ did not dare to freeze its production volume. Instead, it chose to – albeit cautiously – bow to consumer pressure.  This means we are now witnessing a new oil market reality, where producers are forced to take into consideration the wishes and interests of consumers.

The views expressed in this article are the author’s own and do not necessarily reflect Al Jazeera’s editorial stance.