Listen: Can OPEC+ hold its nerve on supply as demand stutters?

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Joel Hanley: Hello and welcome to the Oil Markets podcast from S&P Global Commodity Insights. I'm Joel Hanley. With oil prices dipping ahead of OPEC's planned reintroduction of 2.2 million barrels a day of crude oil in October, can the organization see through its plans or will lower prices make it reconsider? Responsible for the production of around about 40% of the world's crude oil on any given day, OPEC+ is still a major force in the oil markets. OPEC+ is able to control supply, but it can't do very much when it comes to demand. And from October this year, the organization will start gradually unwinding 2.2 million barrels a day of voluntary cuts implemented in late 2022 while 3.6 million barrels a day remain out of the markets until the back end of 2025. However, as OPEC readies itself to bring this oil back on stream, demand has not been as strong as it might've expected and prices are falling. Platts Dated Brent fell from almost $90 a barrel in early July to as low as $76 on August the sixth.

Now since then, it has picked up a bit towards $80 a barrel, but you can imagine this might not be the perfect environment to release more oil into. So what does OPEC+ do? Can it hold its nerve and see through the production increases it is set out to as reiterated in one of its meetings in August the first, or will lowering prices see a change in direction? Also, given the geopolitical fires being fought across the Middle East, the Americas and Eastern Europe, what other pressures is the organization facing? There's a lot to go into and few better than my guests on this edition to discuss it with me. There's Payam Hashempour from our research team where he is the associate director of crude oil markets for Europe, CIS and Africa. And Nick Coleman, senior editor for oil News in the same region. Welcome to you both. Now Payam, let's start with you. OPEC+ seems under quite a lot of pressure as we all are, right? It's a busy time, but can they hold their nerve? Do you see the reintroduction of these 2.2 million barrels, and what do you think the impact will be?

Payam Hashempour: Thanks, Joel. There's one thing that I want to first touch on, and that is that we know that OPEC+ has been remarkably successful in fine-tuning its supply to maintain price stability over the past few months and perhaps few years. And this is despite geopolitical and economic challenges, prices have remain relatively stable, close to about $80 a barrel. Yes, we've had sudden fluctuations, sudden increases, and sometimes the slight drops, but really we've been within that band. Now the decision to increase output in monthly increments could really lead to lower prices, and that's really quite simple as increased supply typically exerts downward pressure on prices.

Now we know that OPEC+ has indicated that these increases could be paused or reversed, and that really depends on market conditions. As you quickly touched on in terms of demand, growth hasn't been as strong. So that could be one of the possible factors that could delay the decision by the main eight producers that are planning or ramping up production from October onwards. So that could play a big part. And this approach really allows OPEC to adapt to the changing market dynamics. These fluctuations in the global demand or unexpected geopolitical tensions that we've seen, they will all certainly play a role, but perhaps we are going to start seeing increases. But at what level and what speed remains to be seen.

Joel Hanley: It's a big organization these days, right? And the bigger you are, the less nimble you can be. You want to take it from me. Now, OPEC does appear to be at odds with other agencies on demand growth, and we've seen that play out over the whole year. And there's a very strange divergence of opinion so late in this year, in 2024, there's over a million barrels a day difference across the demand prediction for the year across the IAEA, the International Edging Agency, the OPEC's numbers, and also our own analysts here at S&P Global Commodity Insights.

Now the IAEA has demand growth under a million barrels a day now for 2024, having repeatedly trimmed that number back from the beginning of the year. We are here at S&P Global, say 1.6 million barrels a day growth for 2024, but OPEC I think is still up around 2 million barrels a day, they're saying in demand growth. And I can't help but wonder if they're wrong, that this release will signal very bearishly to the market. You've got a lot of non-OPEC growth from the Americas, USA, Canada, Guiana and Brazil. There's a lot of oil coming to market, and I just think with OPEC+ opening the taps a bit, so we are going to be awash with oil, aren't they? I mean they're going to have to act very quickly if it goes wrong.

Payam Hashempour: Indeed. And the demand story that you touched on in terms of various organizations' outlook, it's certainly a big question mark for the market. And that's perhaps why we should start to look forward to September, that's when we're going to start seeing clearer indications of how much these OPEC producers are going to ramp up production. So in September, we should start seeing the OSBs from Saudi Aramco and other major producers in the region. And on the other hand kind of seeing the loading schedules and how much oil is being planned to actually be loaded to ships. So September would certainly give us a better idea of which direction we're going on.

And on demand, yes, it hasn't been, I think over the past 12 to 18 months, a lot of us have kind of followed the demand story quite closely. And we can all kind of agree that the reverse demand from Asia Pacific and China certainly hasn't been as strong as a lot of analysts like ourselves thought. But still we expect demand growth. It's not like we expect it to decline, so not as bullish as it was a few months back. So it could raise few eyebrows if OPEC+ started a really ramp up production. And then we started to see demand also declining, and that really will show how far OPEC and OPEC+ will go in terms of regaining some market share. And the question really then remains how much will they let the prices really fall? So again, it will be a challenge in perhaps a few months for US analysts as well.

Joel Hanley: Well, they've had their fingers burned on that strategy before. We'll touch on that a bit in a minute maybe. I mean, one other thing though is that there does seem to be so much all in the market, the conflagration in the Middle East involving Israel or Palestine and now Iran of course, and indeed of course the ongoing situation in Ukraine. Whenever something happens, there's a big geopolitical headline like an attack. There seems to be sufficient oil in the market that we don't really see those jumps in value as we used to. Nick, you're covering these things on a daily basis, the impact, the drone attacks, the assassinations and everything else, and it doesn't seem to be as volatile as it was. I'm guessing that's because there's so much oil in the market and indeed so much in reserve.

Nick Coleman: Yeah, I'd just echo Payam's point about the stability of the oil price that we've seen in the last couple of years and the success of these measures. But it's a bit confusing because obviously we're in the middle of summer for the Northern Hemisphere, and you've got the American US driving season. So actually demand is pretty good and probably slightly outstripping supply right now. But things could get more complicated. Just the unwinding of the production cuts that's due in October. That's going into a winter, which tends to be kind of a soft time for demand. So it'd be interesting to see whether that price of stability is maintained. But in terms of the sort of Middle East situation, it's clearly impossible to predict what is going to happen exactly around the hostilities between Israel and Iran. But the market certainly doesn't seem to be overly kind of stressed by fears of some big conflagration perhaps affecting the Strait of Hormuz in the Gulf.

Just to remind people about a fit of world oil supply tends to travel through the Strait of Hormuz, but that crucial Gulf region for the oil market, I think there seems to be an assumption that it won't be affected. That perhaps Iran doesn't want to upset its own buyers of crude oil, principally China above all else. But I'm not in the business of predicting Middle East and geopolitics and how that's actually going to turn out. But the focus remains really a bit more on the Red Sea and the attacks that we've seen by Houthi Rebels from Yemen since late last year, which I think have been progressively having an effect on oil trade flows. And we've seen a bit of an uptick in these attacks on ships in August coinciding with increased tensions between Israel and Tehran, perhaps to just-

Joel Hanley: But no huge impact on price even so went so far.

Nick Coleman: No, absolutely. Prices have been supported in the... I mean, we have seen futures prices come back above $80 in the last couple of days prior to this podcast, and that followed a bit of a collapse in early August around the week of August 5th. But that was really much more related, I think, to eruptions in the financial markets. Not particularly related to oil.

Joel Hanley: No, I think that's right. And if any market has really seen the impact of the Red Sea situation with the Houthis in Yemen, it is been the freight market because a lot of Suezmax's and Aframax's have had to go further to get where they need to go. They're avoiding the region and commodities are taking a longer time to get where they need to, echoes of the Suez Canal blockage actually a couple of years ago. But one thing I'll ask you though, Nick is the, and indeed Payam, actually, please feel free to chime in on this, the cohesion within the group. Russia might be seen as a pariah to G7 countries and various others and Western nations, indeed Australia and South Korea and so on. But it's still trading very openly in the east and in Africa and indeed in Latin America. So Russia isn't necessarily persona non grata within OPEC, but there are other tensions, I guess, right? They're not only around price direction, but also maybe some political tensions here and there. Have you been impressed with the cohesiveness of this group?

Nick Coleman: Right, so Payam mentioned earlier in the introduction the stability of oil prices to the success of the group in keeping prices kind of in that 70, $80 band. But I think there are questions about what governments actually need to run their countries in terms of oil prices. What's sometimes called the breakeven price for the economies of these countries may be higher, in fact than what we're seeing in oil prices. So the consistent theme is that there've been a couple of OPEC+ producers that have been producing above their limits that are stipulated by OPEC+.

And they seem to get a bit of a blind eye is turned when their production actually exceeds the quotas. And these countries have typically been Russia, Iraq and also a bit Kazakhstan. The other point of course is that Iran is exempt from these production cuts and there just seems to be an accommodation there between Iran and the core OPEC producers, so Saudi Arabia. These two countries traditionally, they're not really considered to have particularly close relations to say the least. But Iran so far is exempt from the production cuts and is actually increasing, its oil production has been steadily rising, the Iranian oil production since 2020.

Joel Hanley: Yeah, the restraint shown by some of the OPEC members. So the traditional ones say UAE, Kuwait, Saudi, between them, they're sitting on about 5 million barrels a day they could be producing, right? But the restraint has been very good from some. How about the others, Payam? You mentioned some overproducing, Nick. Payam, how about the non-compliance plans and the compensation that the group is looking at?

Payam Hashempour: Yes, I mean when we look at those three producers essentially, I mean Russia slightly less so compared to Iraq and Kazakhstan. And there has been recent messages from the Russian Energy Ministry that they will overcompensate for production. But in case of Iraq and Kazakhstan, it seems like a broken record, right? They want to overcompensate, but nothing has really shown in terms of actually under producing to compensate for the overproduction. But kind of going back to the cohesiveness of OPEC and OPEC+, the key members, so really the eight big producers that are planning on actually ramping up production.

We can take a step back and look at 1st of January of this year when Angola left, and then now in the last few meetings that UAE has actually negotiated an increase in production. So we can really look at how the group is looking to be more united, but then we can also raise a red flag that this could be an ongoing issue. So if producers don't start actually ramping up production and they have to go back to the drawing board and then introduce more cuts, then that could certainly play a big role in terms of putting more pressure on leaders of the OPEC+, so the Russians and Saudi Arabia as an example. So it will be fascinating to see how it unfolds. And again, I think Nick again touched on it as well in terms of what we've been seeing in the last few, maybe the first half of August, light sweet crudes have been really benefiting from disruptions in Libyan production.

The forced majority was announced on El Sharara field on the 7th of August. So we're seeing some production also being taken out of the supply picture globally. But on the other hand, like you mentioned, we have five to 6 million barrels at their spare capacity, mostly held by the likes of UAE, Kuwait and Saudi Arabia, available to the market. And that really has proven to be somewhat a cushion in the time that we've seen a lot of geopolitical tensions. We've seen a lot of risks associated to the global commodities market, but we haven't really seen any impact on actual supply. Perhaps one of the reasons we've seen less fluctuation is that cushion of spare capacity, which you touched on as well, Joel.

Joel Hanley: Yeah, there certainly is that cushion. We're not in a contango market. There's still good demand. It's still a backward-dating market generally. But you mentioned Libya, that's interesting because the light sweet grades have really over the last couple of years suffered in terms of price versus the more eastern heavy sour OPEC barrel. If we're talking typical OPEC barrels, it tends to be a bit more sulfurous and a bit heavier. And that of course led to an inversion of the Brent Dubai spread where the light sweet crude was, because there's a lot of it, heading into the West where demand wasn't quite as strong.

And a lot of production cuts on the heavy sours in the East where demand was strong led to inversion of Brent Dubai. And I wonder, Nick, does that speak to a broader east-west divide? So you can talk about the global south and the global north. Maybe we're looking at global west and the global east right here, because OPEC is very much furnishing the east and largely based in the east, I suppose you could say, whereas there's plenty of light sweet crude coming over... indeed, heavier sweet crude from the Americas. And I guess this is all tied up with Russia Ukraine of course, but are we now seeing a global east and global west when it comes to energy?

Nick Coleman: I mean up to a point. Yes, certainly. If you look at Iran as quite a nice example, Iran is generally the top supplier of crude oil to China's independent refinery sector in Shandong province on the coast of China. I mentioned earlier there's this quite close link there between Iran and China. And Russia, as we know obviously has been sending a lot more Urals crude to India. I mean basically before the 2022 full-scale invasion, there was no Russian Urals, as I understand it going to west coast of India. So yeah, a much, much bigger focus on Asian demand. It's not a completely black and white picture obviously. So Russia has been seeking out new demand, new consumers. I think it wants to maintain quite a global role as much as possible within the constraints of sanctions. So South America has been a bit of a battleground for market share, and an obvious battleground that Russia would use Brazil, meeting Brazilian demand for oil products.

So it is not a black and white picture, but just coming back to the Red Sea, that has probably exacerbated this tendency towards a kind of east-west split there because obviously tankers from the Mediterranean or wider Mediterranean region would be now forced to travel around Africa rather than go through the Red Sea. So something like a CPC blend from Kazakhstan, a chunk of that would normally traditionally go to South Korea. Azeri Light, another one produced around the Mediterranean. Again, it's a longer schlep to get to the Asian markets, but Russia, as I understand it from shipping colleagues who follow the shipping market very closely is still sending pre tankers through the Red Sea. And sometimes Russian cargoes are actually being hit by Houthi rebel attacks, which don't seem to differentiate particularly.

Joel Hanley: No, indeed. And you mentioned Brazil as a useful outlet for Russian oil. Indeed, we launched our ULSD, our diesel assessment into Brazil of all origin, therefore, you can assume it probably includes Russian. Having stripped Russian material out to so many of our benchmark assessments at Platts, we now have introduced, yes, this all origin into Brazil to reflect that, you rightly mentioned. Just lastly, Payam, we talked earlier about the market share and I remember in 2014 when OPEC rather bullishly just went for a market share strategy, basically taking on the unconventional drilling in the US to knock out shale. Thinking that at a certain lower price shale would collapse and OPEC would have a bigger share of the market. It didn't work and after a year or two it was reversed and after prices absolutely collapsed. Do you see that much of a play coming from such a large group as OPEC+ as we know it today?

Payam Hashempour: It's hard to say, but I mean we can see how resilient shale production has been to lower prices. We know efficiency around at all rates, especially in the share region, they've been very proactive and they've actually improved very well in terms of their efficiency. So it's hard to see a scenario where OPEC and you know, OPEC+ producers can really go after market share, and prices will decline to a level that we don't expect. Certainly it's a possibility I should add, but it's hard to see it as being the most likely scenario, should I say. On the other hand, it's not just the US, I mean you have Canada, you touched on Guyana, you have the likes of Iran, Venezuela, despite the sanctions, they're producing a lot of oil. You have Russia who's been, although within OPEC+, actually they've done well since the invasion of Ukraine.

So this seems to be a huge surplus of supply that's going to be in the market, despite the fact that OPEC+ will ramp up production and might push some producers out. But I think we are looking at a rather bearish price picture, and that's really due to supply. And then again, as we touched on it earlier, demand will certainly play a big part as well, but I personally can't see a scenario where so much OPEC+ production will really push share production down in a short term. That is, especially I think even if producers actually went on and did start on widening towards that 2.2 million barrels a day of voluntary cuts that is in place at the moment. It will take some time for shale production to really be impacted. So I think in the short term, it would certainly be more bearish for prices before we see any changes in the supply picture outside of OPEC+.

Joel Hanley: Great, excellent point, Payam, thank you very much. Indeed, thank you, Nick, as well. And thank you for listening to this podcast. I'd like to remind listeners all over the world, but specifically in Africa that we will be holding commodity forums in Abuja on the 24th of September, Lagos on the 26th of September, and Cairo on the 8th of October. Now you can find all the registration details on the link in the show notes for this podcast. This episode of the Oil Markets podcast was produced by Felix Fernandez in London.