Since the pandemic struck last year, the energy market has been under a constant spiral of uncertainty. The oil markets experienced the brunt as the world underwent a static pause. Factories closed, travel ceased, and roads no longer bustled with buzzing traffic of routine life. As energy demand suddenly plummeted, the oil producers around the globe started to panic. Reportedly, the oil producers resorted to selling the bubbling supply instead of completely shutting down the production. While a no-demand situation patched with an excess supply stood as an unfavorable bargain, it was still better to supply at a loss than let the rigs dry out. Resulting was a day that no one expected to witness. 20th April 2020. Due to excess supply flooding the market with a practically non-existent demand, the oil prices collapsed. One wonders then how did the markets rebound? Surely the oil-producing countries would have colluded proportionally to cut supply to maintain market equilibrium.
Apparently, the situation was relatively worsened by the very dialogue that should have solved the problem swifter rather than later. In March 2020, the Organization of Petroleum Exporting Countries (OPEC) started a dialogue with Russia to jointly pull back the oil supply in accordance with the reduced global demand. However Russia, being highly dependent on its oil exports, walked out of the dialogue leading to a price war with Saudi Arabia, the largest oil producer in the world. The resulting deadlock ensued a rarely witnessed price war as both Russia and Saudi Arabia started flooding the oil market amid a pandemic. Russia, being the second-largest oil producer in the world, went head-to-head while the market experienced a record drop in demand due to the restricted activity in the world. With excess supply and record low demand, the oil prices crashed beyond historical thresholds. The West Texas Intermediate (WTI) Index, the US benchmark for crude, dropped below zero for the first time in history: slipping down as low as negative $37.63/barrel. The ultra-bearish market defied the laws of derivatives and basic economics as the oil futures verged into the negative territory. The aftermath was a market correction as the sharp price drops alarmed the United States to mediate and push for a resolution. The speculators went out of business as the market was briefly turned worthless, at least on paper. The market only stabilized when OPEC+ (OPEC + Russia) alliance was reconciled and forged a revised agreement to jointly slash the output by 9.7 million bpd in May 2020.
While the oil market stabilized as soon as the dialogue resumed and even gained strong traction once the output cuts finalized, the price war wreaked havoc in a couple of months. Reportedly, the price war resulted in an estimated 65% quarterly fall in the oil prices in just two months. Now, as the market has finally started showing a rebound in terms of demand, another stalemate seems to threaten the recovery of the oil market. And while the talks are still in progress, it is worth realizing what another price war could subsequently bring to the table, especially as the global economy is still reeling through the pandemic.
The recent meeting of the OPEC+ alliance was on track to approve a proposal to loosen the curbs placed on the crude output last year. The proposal was in line with the bullish trend in the oil market as global demand has picked pace in the Second Quarter of 2021. The continual upward trend in demand is clear from the performance of both the global crude benchmark Brent and the United States’ crude benchmark WTI. Both benchmarks surpassed the $75/barrel mark last week to settle at the highest levels since the production baselines were originally placed in October 2018. Therefore, the OPEC+ alliance was proposed to increase the output of each member by 400,000 bpd from August through December 2021. The suggested hike would allow the OPEC+ alliance to pump an estimated 2 million bpd of production by the end of 2021, thus, stabilizing the overly bullish market by matching the oozing demand with an incrementally increased supply. While the ease of production was not a direct matter of contention, the proposal was left in the air as UAE followed on to object to the latter part of the proposal.
The pitched proposal further called for a deferment in the previously agreed supply cut expiration from April 2022 to December 2022. The clause was pushed into the proposal as the global demand still seems to be staggering in the face of a still active pandemic. The decision to retain the supply cuts through 2022 would safeguard against a possible collapse of demand as the airline industry, one of the largest consumers of petroleum, would reportedly drag to complete normalization until 2023. Thus, the supply cuts would help control the market and avoid another excess supply scenario. However, the plan to extend the supply cuts – currently standing at 5.8 million bpd – did not bode well with UAE.
The UAE apparently had no problem with the multilateral ease of supply from August to December. However, the Emirati regime demanded a unilateral increase in the output past the baseline levels agreed. Since UAE’s oil production capacity had pumped up from 3.16 million bpd back in October 2018 to 3.841 million bpd in April 2020, the Emirati state wants its baseline to be leveled up in accordance. Moreover, UAE also objected to the proposed extension in the supply cuts expiration through 2022. In response, the state demanded to lock an increase in production before extending the agreement beyond the April 2022 expiration. The deadlock, thus, impeded the proposal and continues to pose a significant problem; to the alliance, sure. But to the broader market as well.
Gauging a broader perspective, the proposed extension in the output by an additional 2 million bpd through the end of 2021 would boast the supply significantly. However, the relative global demand increase of an estimated 6 million bpd would still render the market with a bullish sentiment. The underlying nature could be assessed by the response of both Brent and WTI as the duo inched past the $76/barrel mark while the talks were in progress. It further proves that the surge is not transitionary. However, the strong market could be threatened by UAE’s adamancy in its objectives overriding the proposal of the OPEC+ alliance. The resulting impasse poses two scenarios.
If UAE is allowed a unilateral increase in the output benchmark, the OPEC+ alliance could weaken in its foundations. An increase in the baseline for UAE could alienate the other 32 countries forming the OPEC+ alliance. Russia would be a prime contender as almost 60% of its economy depends on petroleum exports. While Russia has led the camp of members including towards a supply increase, the Kremlin would not allow a unilateral hike which could plausibly fuel resentment within the alliance. Moreover, a shifting baseline for a single member would create confusion in the market as the remaining members would stand out of sync. The perplexing benchmarks and variating supplies could plunge the market into the same pit of darkness that the participants faced last year as the pandemic caused the oil market to go haywire. This is one of the main reasons why Saudi Arabia, the de facto leader of OPEC, would rather join muscle with Russia than UAE: to retain equity in the alliance and – by extension – in the broader market.
If UAE is not granted the easement in the proposal, which is the likeliest outcome, a ’No-Deal’ scenario could result in lasting fissures in the Saudi-UAE alliance with a high possibility of UAE exiting from the OPEC+ alliance. The UAE had earlier alluded in 2020 that it could exist as an independent entity, splitting from the OPEC+ alliance and pouring its spare capacity through its national Murban Crude Oil Index. However, with an uneven recovery in the global demand due to the returning nightmare of the Delta variant of the coronavirus, a splitting supply in face of a plummeting demand could lead the market into another price war. Regardless of demand, a contending supply could still upend the rally in the oil prices, impeding the recovery in the process.
The oil market, much like any other market in the world today, is still only recovering from the pandemic. The demand is only picking up months after a historical crash. While the trend seems strong and lasting in nature, ease of supply – even if 2 million bpd – could pull the market down if the demand retracts in the following months. Unlikely but plausible. However, the alliance awaits another meeting to further discuss the prospects of passing the proposal without any significant supply shocks. The backend channels would most likely play a crucial role to avoid a repeat of last year. Saudi Arabia, a strict member adhering to tight supply measures, would push for reconciliation rather than a detachment of UAE. Especially when Iran is all set on the sidelines to pour its exorbitant oil supply in the global market following a breakthrough in the Vienna talks. However, UAE would probably attempt to leverage its position as well. While not to the point of breaking loose from the alliance when the global market is so uncertain, UAE would surely drive some value out of this deadlock before it ultimately agrees to comply. Whatever follows in the following days, another fallout in the alliance would be a sight to marvel: it’s unclear, however, in which direction.