OPEC and Russia: Will history repeat itself?

OPEC’s recent meeting took just 10 minutes to decide there was no shortage of oil and no need to change its prescribed course. Markets thought differently, opening the following Monday and promptly soaring to $139 per barrel for Brent crude, within touching distance of 2008’s all-time nominal record of $147. The oil exporters’ organization is in danger of repeating past mistakes.

The OPEC+ group has laid out a policy of steady production increases, adding 400,000 barrels per day (bpd) each month up to May 2022, then slightly more each month thereafter with a reset of baselines to higher levels for Russia, Saudi Arabia, the UAE, Kuwait and Iraq. The UAE ambassador in Washington suggested on March 9 his country favored higher production levels, helping send prices lower, while his energy minister followed up by tweet that this would only happen within the OPEC framework.

Even before the Russian invasion of Ukraine, OPEC+ was struggling to deliver. Nearly all of the non-OPEC members, other than Russia and Kazakhstan, and significant OPEC members — Angola and Nigeria — were falling well short of their targets. By January, Argus estimated the group was 800,000 bpd below its collective target (excluding the three exempt members, Iran, Libya and Venezuela). Very few people took seriously the forecasts of OPEC and the International Energy Agency that the oil market would be in surplus early in 2022.

Even for those members with some spare capacity, it was clear that Russia was close to its maximum without a substantial revival of drilling, and that Iraq and Kuwait would hit their limits around the third quarter. That would concentrate all available spare capacity in Saudi Arabia and the UAE. If regular monthly increases continued, national targets would reach the baselines by September 2022, at which point the UAE would have about 0.5 million to 0.7 million bpd of spare capacity, and Saudi Arabia about 1 million bpd. Under a revived Joint Comprehensive Plan of Action (JCPOA), Iran could return some 1 million to1.3 million bpd over a few months.

Saudi Arabia plans to add another 1 million bpd of capacity and the UAE another 0.8 million to 1 million bpd from current levels, but over several years. Iraq’s 7 million bpd target by 2027, adding about 2 million bpd, is much more doubtful to achieve.

On March 2, OPEC+ was reluctant to change course, despite Brent crude trading around $113 per barrel during its meeting, Russian crude at double-digit discounts to that, the steepest backwardation on record at almost $16 per barrel for the six-month spread, and already initial signs of reluctance to lift Russian cargoes. Shell, BP and Equinor had all announced they would quit the country.

Explanations fall into three groups (and are not mutually exclusive). The first perceived motivation is that Saudi Arabia and the UAE are upset with a perceived lack of U.S. support over drone and missile attacks from the Houthi forces in Yemen and/or from Iran, the snub of President Joe Biden to Saudi crown prince Mohammed bin Salman, as well as the attempts to negotiate a return to the disliked JCPOA with Tehran.

The second is that the Gulf producers are hedging their political support, reminding the U.S. of their importance and that they have the option to tilt a little more toward Russia or China. They do not want to annoy Russia, an important power broker in parts of the Middle East, and where they have substantial investments.

The third factor is that the Gulf states do not want to lose continuing cooperation with Russia in the OPEC+ framework, a long-sought outcome that Moscow never delivered on before 2016. This was essential in managing the shale-driven bust post-2014 and the COVID-created collapse of April 2020.

But whatever the motives, we have also to look at the effects. OPEC+ may be relatively sanguine on competing supply, given the slowness of U.S. shale companies to speed up investment, as well as the equipment and labor bottlenecks. But demand destruction and a steep global recession is all but inevitable if oil prices escalate much further and European and Asian natural gas prices remain around current levels.

And such high oil prices plus the geopolitical imperative to diminish reliance on Russian crude will give a tremendous impetus to electric vehicles. Plug-in cars already had a 26 percent European market share in November 2021. This risks an eventual repeat of the 1980s demand and price slump — but with decarbonization goals ensuring that this time it will be permanent.

Of course, OPEC+ faces an almost irreconcilable challenge. Only four member nations have a short-term economic interest in higher production allocations, and two of those are about to run out of headroom. Just agreeing the modest quota realignment in July 2021 took a UAE walk-out and hints of leaving the organization entirely.

Energy Intelligence suggested that Russian oil exports were down by about 2.5 million bpd already; even at maximum output, OPEC could barely cover that now. Of course, it will seem easier to wait until April, and look for harder evidence of disruptions and shortages. That would avoid confrontation with Russian Deputy Prime Minister Alexander Novak and his boss. It was always going to be uncomfortable inviting into Vienna a country which felt itself a superpower not just in petroleum but in political and military capacity.

Yet, one of the central pillars of the OPEC+ edifice is Russia — and specifically, a Russia that is a large and growing oil exporter, which poses a serious market challenge to the core OPEC members. If Russia is going to become a larger and snowier version of Venezuela, that pillar collapses. Riyadh, Abu Dhabi, Kuwait City and Baghdad have a once-in-a-generation chance to seize, with their giant, low-cost and low-carbon reserves, a much greater share of a market about to contract sharply.

Robin M. Mills is non-resident fellow at the Center on Global Energy Policy at Columbia University, CEO of Qamar Energy, as well as author of “The Myth of the Oil Crisis.”