OPEC Faces 'Nightmare Scenario' Over Oil Prices

The infamous OPEC+ meeting is to be held on December 1, 2024, and the press has already started speculation as to the possible outcomes. 

Since 2022, the group has been withholding about 3 MBPD to 5 MBPD of oil out of the market in various forms. Saudi Arabia has been doing most of the heavy lifting with their voluntary cuts in place for more than a year. Eight of the OPEC+ nations that had withheld about 2.2 MBPD of voluntary cuts, were meant to bring them back by the latter end of this year. But these keep getting pushed out month after month as prices and demand, for that matter, fail to bounce. They have been waiting since the second half of 2024 to see demand from China rebound as had been pencilled in by every western analyst at the beginning of this year. We have only one month to go, and there are no signs of Chinese demand picking up to speak of.

Today, brent oil prices are still trading where they did back in 2010! Outside of a few exogenous shocks like the Ukraine war, prices never got above $120 per barrel sustainably. Why is that, when there is so much talk of peak oil demand getting pushed out? 

Commodities boil down to simple demand versus supply dynamics. If it is left to its natural forces, then either side adjusts allowing for true price discovery. Since oil prices fell down to negative WTI during the COVID-19 pandemic, OPEC+ desire is to avoid that scenario in the name of "price stability," but truth be told, the entire future of that region and their growth alternatives depend on their key revenue source, i.e., oil. They cannot afford to let it drop too much or for too long lest they are not able to diversify into other non-oil revenues fast enough. Saudi Arabia has already overspent its future oil revenues in anticipation of higher prices to come, such that its fiscal breakeven price is closer to $90 per barrel of brent, not the $70s where it is trading today.

The thing about "controlling" prices is that it allows high-cost producers to ramp up production as they are incentivized to keep pumping at the cost of the nation that is holding it back. The fair value of the marginal barrel today is somewhere in the region of $50 per barrel to $60 per barrel. China was meant to grow its demand by 800,000 BPD, yet the first 10 months of this year has seen its demand fall by 400,000 BPD. OPEC+ demand numbers are seriously misguided, and they keep tweaking it by small amounts each month only to delay the revival of their production by another quarter. Going into the December meeting, it is expected that they have no choice but to push these barrels further into Q1 2025.

What was meant to be a few months of holding back production to put a line under oil prices has turned into a real nightmare scenario for them as each day that passes by, demand in the global economy looks precarious with China's decline being secular and not cyclical. 

But there is a silver lining: The Biden administration has been quite lenient compared to Trump when it comes to Iran. It is no mystery that Trump gets along with Saudi Arabia much better than Biden ever did. Trump’s nomination came into force as his presidency focused on lowering prices and the cost of living for the American people. Trump is known to be a deal maker. Some basic back-of-the-napkin calculations would suggest that if Saudi Arabia allowed prices to fall, they could easily ramp up more volumes to make up for the shortfall given their space capacity at the cost of Iranian barrels and come out guns blazing. But that would mean alienating Russia, which has been their new closest ally at the cost of U.S. protection. 

Slightly above my pay grade, but at the end of the day, the game is the same, just the players change. There is no shortage of oil. 

At the time of publication, Bengali had no positions in any securities mentioned.