The oil market is rapidly shifting from a
period of over-supply during the height of the pandemic to one of
potential shortage. Producers who managed the slump now need to be diligent in
managing the recovery.
The oil producing countries in the OPEC+
group — led by Saudi Arabia and Russia — have done an
amazing job at managing oil supplies as demand has crawled its way back
from the biggest collapse in history.
Sure, they got off to a shaky start.
Instead of slashing supply as demand cratered in April 2020, they boosted it in
a production free-for-all after their previous cooperation fell apart. The deal
that emerged when they eventually got together took days to form and almost
foundered on the unwillingness of Mexico to play its part.
But after some vague pledge from
President Donald Trump that the U.S. would make up the cuts that Mexico
refused, the producer group announced a record output reduction of almost 10
million barrels a day. And, for the most part, it has stuck by what it
promised.
Sticking to the Deal
Even without the extra Saudi cuts,
compliance has been close to 100%
As always, there are those who haven’t
done all they pledged. Some, most notably Russia, have been given a free pass.
Others, like Iraq, Nigeria and most visibly the United Arab Emirates, have
been called out and persuaded to compensate with even deeper cuts. Saudi
Arabia twice made additional unilateral reductions to its production to speed up
the process of market rebalancing.
Demand is now well on the road to
recovery — literally. Highway traffic is back at, or even above, pre-pandemic
levels in the U.S., China and large parts of Europe. Domestic and regional
aviation is also picking up. The number of passengers passing through
security at U.S. airports surpassed 2 million a day for the first time since
March 2020, while European air traffic has risen by one-third in the
past month. The remaining weak spot is long-haul flying, which is still
constrained by restrictions on incoming passengers in many parts of the world.
Flying High
For the first time since March 2020, the
number of passengers flying in the U.S. has exceeded 2 million twice this month
As the story has switched from collapsing
demand to recovery, however, it’s now supply that is
lagging. That’s partly because the OPEC+ producers want to keep
draining stockpiles, deliberately pumping less than their customers are using
to whittle away the excess inventory built up during their slow response to the
onset of the pandemic. But it’s also because oil companies aren’t investing in
new production. That’s not yet a serious problem, but it could become one.
Some of the companies’ reluctance is
due to pressure from shareholders, who are either pushing for more
environmentally conscious business models or seeking better returns on their
investments. Some is simply due to oil incomes getting hit hard in 2020,
which forced companies to slash budgets.
The OPEC+ countries have the capacity to
raise output quickly, although maybe not by as much as we’ve been led to
believe. Spare capacity is concentrated in just a few of the 23 countries,
and the two biggest probably have less of it than the numbers used in the
production cut deal indicate.
OPEC+ Oil Buffer Isn't All It Seems
Spare capacity is concentrated in only a
few of the group's members
Sources: OPEC+ member data, IEA,
Bloomberg calculations