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Home›OPEC›The big oil companies’ new problem is not lack of demand, it’s lack of supply

The big oil companies’ new problem is not lack of demand, it’s lack of supply

By Loriann Hicks
June 20, 2021
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The oil market is rapidly moving from a period of oversupply at the height of the pandemic to a period of potential scarcity. Producers who have handled the crisis now need to be diligent in managing the recovery.

The oil-producing countries of the OPEC group – led by Saudi Arabia and Russia – have done an incredible job in managing oil supplies as demand receded after the biggest collapse in the world. history.

Of course, they got off to a rocky start. Instead of reducing supply as demand collapsed in April 2020, they boosted it into free-for-all production after their previous cooperation collapsed. The deal that emerged when they finally came together took days to form and nearly crumbled over Mexico’s reluctance to play its part.

But after a vague promise from President Donald Trump that the United States would make up for cuts denied by Mexico, the producer group announced a record cut in production of nearly 10 million barrels per day. And, for the most part, he stuck to what he promised.

As always, there are those who did not do everything they promised. Some, notably Russia, received a free pass. Others, like Iraq, Nigeria and more obviously the United Arab Emirates, have been called upon and persuaded to compensate with even bigger cuts. Saudi Arabia has twice made further unilateral production cuts to speed up the process of market rebalancing.

Demand is now on the road to recovery, literally. Road traffic has returned to pre-pandemic levels, if not above, in the United States, China and large parts of Europe. Domestic and regional aviation are also recovering. The number of passengers passing security checks at US airports topped 2 million per day for the first time since March 2020, while European air traffic has increased by a third in the past month. The remaining weak point is long-haul flight, which is still limited by restrictions on inbound passengers in many parts of the world.

While the story has turned from collapsing demand to recovery, it is now supply that is lagging behind. In part, that’s because OPEC producers want to continue to deplete inventory, deliberately pumping less than their customers are using to reduce excess inventory built up during their slow response at the onset of the pandemic. But it is also because the oil companies do not invest in new productions. It is not yet a serious problem, but it could be.

Part of the reluctance of companies is due to pressure from shareholders, who are either pushing for more environmentally friendly business models or seeking better returns on their investments. Some are simply due to the hard-hit oil revenues in 2020, which has forced companies to cut budgets.

OPEC countries have the capacity to increase production quickly, but perhaps not as much as one might have thought. The spare capacity is concentrated in a few of the 23 countries, and the two largest probably have less than indicated by the figures used in the production reduction agreement.

One reason is that the benchmark production levels used for the two largest producers, Saudi Arabia and Russia, were arbitrarily set at 11 million barrels per day when the deal was struck for the first time in April 2020. This has allowed Russia to claim a bigger cut than it actually has and is more than it can pump. It is also more than what Saudi Arabia produced at any time, except during its production surge of April 2020. Other countries, notably Angola, have seen their production capacities collapse as investments were stagnating.

The true increase in available production is likely closer to 4.5 million barrels per day, rather than the 5.8 million barrels suggested by the numbers in the deal.

The US shale patch is yet to respond to higher prices with increased activity, at least not on a scale large enough to more than offset declines in wells already in operation. Production has been stuck at around 11 million barrels a day for a year, although the number of oil rigs has doubled since August.

While OPEC countries have increased production over the past two months, they currently have no plans to do so after July until their current agreement expires next May.

That will have to change. The group is scheduled to meet on July 1 and continue to meet monthly thereafter. He will have to act to prevent oil prices from rising enough to stifle the recovery.

Saudi Energy Minister Prince Abdulaziz Bin Salman said last week that it was up to him, along with others, to ensure that another super cycle in global oil prices does not occur. To do so, he will need to handle the return of OPEC production as carefully as he has handled its reduction – and perhaps tone down the caution for which he is now known.

This story was posted from an agency feed with no text editing.

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