Prospect of European embargo and price cap on Russian oil, along with rising winter demand, are weighing on the production group

Benoit Faucon and Summer Said, WSJ

LONDON/DUBAI
EnergiesNet.com 11 23 2022

The specter of an oil-supply shock this winter has created a dilemma for OPEC and its wider circle of crude producers about whether to reverse course on the production cuts it set last month.

Beginning in early December, the oil market will face a series of looming problems that some members of the Organization of the Petroleum Exporting Countries see as a potential opportunity to pump more oil and others view as a reason to stay the course with their production cuts.

In the past two weeks, OPEC members began informally discussing the potential need for more oil this winter, OPEC delegates said. The initial trigger was data showing rising oil demand in the coming months, a normal seasonal adjustment caused by European and North American burning of fuel oil, delegates said.

There were other concerning data points, delegates said. On Dec. 5, one day after OPEC meets with other producers including Russia in Vienna in a gathering known as OPEC+, the European Union is set to impose an embargo on Russian oil. On the same day, the Group of Seven leading nations is set to impose a price cap on Moscow crude. Russian officials have said they won’t sell oil to countries that impose a price cap, raising the prospect of a supply gap if Russian oil doesn’t find buyers.

Further, there has been disappointing news from U.S. shale country, where companies didn’t drill more to take advantage of high prices this year. And finally, big OPEC producers such as the United Arab Emirates and Iraq have long been chafing under production limits they feel are too low, the delegates said.

With all of these energy-market headwinds emerging, some OPEC+ delegates have begun discussing—including OPEC’s biggest member, Saudi Arabia—whether to reconsider the production cut engineered last month of 2 million barrels a day, the delegates said.

The production cut was controversial, with the White House contending that it aligned OPEC+ with Russia’s war effort in Ukraine. The Saudis have said the cut was economically justified, and a growing group of oil-market analysts agree with their assessment after oil prices didn’t shoot above $100 a barrel.

The discussions are still early, and OPEC+ could decide to do nothing at its Dec. 4 meeting or even cut more, as Saudi Energy Minister Prince Abdulaziz bin Salman suggested in a statement Monday. Prince Abdulaziz denied there were discussions of a production increase of 500,000 barrels a day, which The Wall Street Journal had reported was the higher end of what delegates were talking about.

OPEC+ delegates said Prince Abdulaziz’s denial of talks reflected an unease with public discussion of the group’s decision-making before an agreement with Russia had been struck. As the two biggest producers in OPEC+, the Saudis and Russians generally rule the group by mutual agreement.

The precipitous drop in oil prices that followed the Journal’s story likely reinforced the view that even a partial reversal of the production cuts would be a bad idea, said Helima Croft, the commodities chief strategist at Canadian broker RBC, in a note to clients.

Prices dropped more than 5%, and WTI, the U.S. benchmark, fell below $80 a barrel for the first time in two months. The market pared those losses after Prince Abdulaziz’s statement. On Tuesday, Brent crude, the international benchmark, and WTI were both up more than 2%.

Ms. Croft, who attends OPEC meetings, said OPEC+ was likely not to make any drastic decisions until after the EU imposes its oil embargo, when “there is clear information about the size of the Russia supply gap.”

“We think the kingdom will seek to strike a balance between assisting Europe with additional barrels and preventing a selloff that would imperil the OPEC+ producers’ newly bolstered balance sheets,” Ms. Croft said.

Echoing some OPEC+ delegates, Ms. Croft said there was the possibility that OPEC could adjust the baseline production levels of some producers, which could lead to an effective production increase.

The U.A.E. is the most prominent example of a producer that has OPEC production baselines that are lower than actual capacity. Its OPEC production baseline is just over 3 million barrels a day, but its capacity is more than 4 million barrels a day. The Persian Gulf country denied Tuesday that it is seeking an OPEC+ production increase, but it has long been known to market participants to be pushing for OPEC to acknowledge its higher production capacity and allow it to pump more.

Production baselines are a sensitive point in OPEC’s fractious internal politics.

Countries such as the U.A.E. have been spending billions of dollars to build out their capacity in a bid to pump as much oil today as possible before a transition to renewable energy takes hold across the world. But raising the U.A.E.’s OPEC production baseline would likely entail examining the baselines for countries such as Nigeria and Angola, which didn’t invest in their infrastructure and fall far short of their baseline levels. Nigeria and Angola oppose such revisions.

The U.A.E. has consistently pumped above its OPEC-imposed production limit of 3.18 million barrels a day, often hitting 3.5 million barrels a day.

OPEC talks about a production increase come as the oil companies behind America’s fracking boom disappointed analysts who had expected U.S. oil production to grow by at least 1 million barrels a day this year as oil prices surged to multiyear highs.

Instead, shale drillers kept their output roughly level, following marching orders from Wall Street for them to return excess cash to investors via dividends and buybacks or pay off debt, rather than pump money back into the oil patch, as they had for a decade. Several companies generated record amounts of free cash flow.

U.S. oil production has increased less than 3% since December, to 11.98 million barrels a day as of August, according to the latest monthly data from the Energy Information Administration. The EIA cut its forecast for year-end U.S. oil production by almost 500,000 barrels a day compared with its March forecast, and by 770,000 barrels a day for year-end 2023.

—Collin Eaton contributed to this article.

wsj,com 11 23 2022