Capacity - OPEC's Giants Claiming Ground Despite Uncertain Crude Oil Market

Producers of crude oil face historic insecurity about their market. Not only is there still uncertainty stemming from COVID, oil demand is also under pressure as governments and international organizations push to replace fossil fuels with energy forms free of hydrocarbons. Members of the Organization of the Petroleum Exporting Countries (OPEC) face special challenges from measures taking shape to discourage oil use. Their economies, more than most others, depend on oil sales and many members of the exporters’ group have limited sources of replacement income. Yet OPEC producers do not lack leverage in a market expected to grow at diminishing rates and eventually shrink. Many of them can produce crude oil much less expensively than counterparts elsewhere and some of them plan to profit from that advantage by increasing output, even as the market flattens, and are investing to raise production capacity to ‘get while the getting is good.’ In today’s RBN blog, we look at capacity-boosting plans within OPEC, explain why most members cannot take part in the effort, and describe how this developing priority might intensify market competition.

Driving the transition away from hydrocarbon energy is, of course, concern about emissions of carbon dioxide and other greenhouse gases (GHG) accumulating in the atmosphere. It remains uncertain whether aggressive decarbonization goals announced by many governments, including the U.S., are fully achievable. What is certain, as we have asserted in blogs such as The Air That I Breathe, is that efforts aimed at energy transition have been gathering momentum. That means demand for oil products — and, therefore, crude oil — could peak and begin to decline sooner than would happen if energy decarbonization had not become a priority, especially after the 2015-16 Paris Climate Agreement (see Bullet The Blue Sky). Already, U.S. exploration and production companies are reining in their investments, partly in response to investors and lenders concerned about the future of oil (a trend we covered in our Paradise blog series). Some of the major oil companies, too, are deemphasizing oil in long-term plans aimed at slashing carbon dioxide emissions. These are understandable responses to the uncertain future of oil demand. But it also makes sense for producers to want to hold or even gain ground in the market for as long as possible — one which, despite pressures to decarbonize, likely won’t vanish anytime soon. Even with electrified transportation and electricity increasingly generated by solar and wind energy, the world will still need oil. They’re not partying like it was 1999 but, with time left before the music fades, some OPEC members are adding production capacity. The United Arab Emirates (UAE), for example, delayed an important OPEC production decision until the group accommodated the federation’s capacity expansion by lifting its quota baseline. As we suggested in Surprise, Surprise, the move will push production capacity closer to the center of attention in future OPEC deliberations.

To varying degrees and in various ways, OPEC has aligned individual production quotas with its members’ abilities to produce crude oil since the 1980s. But the benchmark has been country-level reserves — the volume of oil known with reasonable certainty to exist underground and to be producible with available technology at prevailing crude prices. As a central metric for policymaking, reserve is a malleable value, subject to fluctuation and reliant on interpretation — even fudging by OPEC members eager to elevate their production quotas. But it has served the interests of reserves heavyweights like Saudi Arabia, Kuwait, and the UAE, whose leaders traditionally have sought to preserve the value of unproduced crude oil for future generations. Especially after the crude-price crash of the late 1980s, those countries usually worked to keep the market adequately supplied and prices below levels that might stimulate development of alternative energy forms. OPEC members with lower reserves have tended to favor more aggressive supply restraint, especially when other members made the production sacrifice. For them, immediate price elevation was more important than the value of crude at some indistinct point in the future, when their reserves might be at or near exhaustion. Especially when negotiating production cuts during periods of oversupply, OPEC has had to balance these divergent interests between members richly endowed with oil and those much less so.