Despite Increasing Demand and OPEC+ Cuts, Higher Oil Prices Face Uphill Battle in 2021

On January 5th, Saudi Arabia moved markets by agreeing to a surprise cut in February and March production of one million barrels per day (bpd), to 8.1 million bpd. Since the announcement, Brent Crude rose nine percent as of January 19th. OPEC+, including major producers like Russia, is scheduled to meet again February 3rd. Going forward, the expanded OPEC group will meet monthly to discuss possible further production cuts in light of the weak economic recovery and the signs that global energy demand will not return to pre-pandemic levels until 2022. The slow roll-out of COVID-19 vaccines has dampened market expectations for 2021. While oil demand from China, the world’s largest oil importer, is expected to continue rising, the outlook for Europe and North America is bleak. OPEC+ currently aims to stabilize the market, creating more certainty for investors and securing government revenues. Even if OPEC+ nations comply with current or new output targets, it remains to be seen whether this alone can sufficiently stabilize the market and secure state revenues. Prices will likely remain subdued as US shale production increases in response to Saudi output cuts, the Biden administration follows through on its promise to lift Iranian sanctions in exchange for a nuclear deal, and a recovering economy stabilizes the US dollar.

Price Sensitive US Shale Oil

The rise of the hydraulic fracturing industry since 2009 made America an energy superpower, producing 19 million barrels of oil a day in 2019. Despite being the world’s largest oil producer in 2019, the United States saw production slow. In early 2020, the Saudi-Russian price war and Covid-19 brought unprecedented volatility to global oil markets, disrupting energy production around the world, particularly in the US. Crude oil futures cratered as global demand fell 5.6% in the first quarter and by nearly 20% in  June 2020 to just 83 million bpd.  

Producing 70% more than the second largest producer, Saudi Arabia, America exerts a large influence on the price of crude worldwide. According to the Baker Hughes index, the number of American oil rigs in operation fell from  800 to 244 in August, nearly 70%. As the number of rigs in operation falls, individual rig productivity increases, and breakeven prices in many regions have fallen to $40 per barrel. 

Last week, OPEC  warned against a ramp up in American oil production, citing the experiences of the past price wars between OPEC and US shale operations. The number of oil rigs in the US has recovered, up nearly 50% since the August low, but remain well below the pre-crisis levels. With investors still shaken from Chesepeake’s recently resolved bankruptcy, US shale faces considerable incentive to produce more. Even with a Democratic sweep, the Biden administration has not shown credible interest in banning hydraulic fracturing. Stakeholder expectations suggest the new administration will maintain many of the same policies to continue realizing the gains of an energy independent America. The centrist Democrats in both Congress and Senate know they will pay the price in the next election if they choose to destroy oil and gas jobs that many of their constituents rely upon, especially during a time of great unemployment. 

The Biden Administration

Politics outside of OPEC+ will also play a role in oil prices. The new administration plans to reverse some Trump era sanctions surrounding oil exports. Biden has promised to re-enter the Joint Comprehensive Plan of Action (JCPOA), a deal to lift economic sanctions currently banning Iranian oil in exchange for denuclearization in Iran. In recent weeks, Iran has ramped up its uranium enrichment to use as a bargaining tool for negotiations in the Middle East and the incoming president-elect. Biden has already taken steps towards the JCPOA by nominating the 2015 Iran nuclear deal negotiator as Deputy Secretary of State. If the deal goes through, the market will have to absorb Iran’s oil exports as the Iranian government seeks state revenues after years of budget deficits. Given Iran’s status as member of OPEC, new output agreements will need to be negotiated. However, these agreements may be hard to reach as OPEC’s de facto leader, Saudi Arabia, and Iran are engaged in military proxy conflicts across the Middle East.  

Biden expressed interest in adjusting the Venezuelan sanctions currently amplifying the country’s humanitarian crisis. Regardless of the steps that might be taken by the new administration, the Venezuelan government plans to increase oil exports.  On January 14th, Reuters reported on talks held between the private oil producers and the Venezuelan government, which for decades have nationalized oil production through the state-owned company PDVSA. The talks revealed that in an effort to bolster the economy, the nationalist socialist government may concede to permitting private producers to receive the revenues from their production of oil. While details remain confidential, President Maduro announced in an address on January 12th that he aims to increase production to 1.5 million bpd, well above the 434,000 bpd reported in November 2020. 

 Lower on the list of the Biden administration’s foreign policy decisions are sanctions regarding Russia. The Obama administration had placed sanctions targeting Russia’s economy in 2014, which the Trump administration later reversed. The sanctions devastated Russia’s economy; however, the collapse can largely be attributed to the fall in oil prices. Exports experienced only a small decrease before recovering to their pre-sanction levels by the time Trump entered office. While the Biden Administration has vowed to punish Russia for its hacking and cybersecurity attacks on American institutions, a promise that may be further incited by the recent arrest of Alexei Navalny, the sanctions will be targetedand won’t overtly affect oil exports.  

US dollar and Economic Policy 

Another tailwind to oil prices, which are priced in USD, has been the decline in the USD index. After spiking in March when investors demanded safe assets like US treasuries, the Dollar index has fallen by 10%. In an effort to save the world from a repeat of the 2008 financial crisis, the Federal Reserve continues to flood financial markets with dollars. Largely due to the massive expansion of monetary policy in combination with investors currently seeking greater returns in assets not denominated in USD, the value of the US dollar has slid since the crisis began. When the recovery does come, the Federal Reserve will reverse their lenient monetary policy. Additionally, the Congressional Budget Office anticipates fiscal spending to decrease as the economy begins to normalize. These policy changes will create upward pressure on the dollar and downward pressure on crude oil. 

Much uncertainty lies ahead for oil prices in 2021 and throughout the rest of the new decade, but certain challenges lay on the horizon: Non-OPEC members' willingness to produce at $50+/barrel will test OPEC ambitions to limit supply and create stability. OPEC will also face a new American administration that will adjust sanctions limiting six percent (combined production of Iran and Venezuela in 2015) of the world’s production as well as a stabilizing US dollar. Of the remaining uncertainties, most hold downside risk to the price of oil and very few, aside from a major conflict in the Middle East or a Biden administration that completely bans US production or Russian exports, will increase prices. OPEC’s choice to create OPEC+ in 2016 reflects the growing difficulty to control oil prices in a world with more competition and less demand than ever before. The next decade may prove this expansion insufficient as political, economic and technological factors play an increasingly larger role in the oil market.