On December 10, 2021 the group of oil producers known as OPEC+ marked five years since the alliance was formed in the wake of the 2014-15 oil price crash. The new year has given OPEC and its Russian-led non-OPEC allies further cause for optimism as oil prices opened above $80 per barrel in January and have moved higher in the weeks since. This is mainly due to a market management policy that allowed its 23 members to restore balance to a market knocked off its course by the onset of the coronavirus pandemic in 2020. Recent geopolitical developments over the Russian troop buildup on the Ukrainian border and an attack by the Houthis in Yemen against the United Arab Emirates are also bullish factors that have driven prices up to a 7-year high.

But this does not mean that OPEC+ can rest on its laurels as producers roll back steep production cuts with some member countries unable to meet their higher quotas. Rising oil prices have been a welcome gift to the producers, allowing most to recoup some of the steep revenue losses from when oil prices crashed and demand shrank as the coronavirus pandemic struck and wreaked havoc with the global economy.

The deadly attacks on January 17 against Abu Dhabi, claimed by the Houthis in Yemen, pushed oil prices to their highest level since 2014. Although oil and gas operations were not disrupted in the UAE, the third-largest producer in OPEC after Saudi Arabia and Iraq, it was the most serious attack in recent memory against one of the most stable countries in the Middle East. The UAE was part of the Saudi-led coalition that in 2015 launched an offensive against the Houthis after they had overtaken the capital Sanaa forcing Yemen’s president to flee. Although Abu Dhabi has withdrawn most of its forces in Yemen as the war dragged on, it continues to support Yemeni factions fighting the Houthis.

The oil market has been on alert since the start of the year over the Russian troop buildup on the Ukrainian border; the UAE attack pushed prices even higher. On January 19, global benchmark Brent crude traded above $89/bbl in reaction to fears of an escalation of the Yemen conflict, which has already spilled over into Saudi Arabia, where oil installations have been targeted repeatedly.

Geopolitical developments aside, the OPEC+ producers have had to tread carefully along a pathway that has thrown a number of surprises along the way since a hard-won agreement in April 2020 to slash production by a collective 9.7 million barrels per day following a tussle between Saudi Arabia and Russia that flooded the market with unwanted oil. With inventories saturated with crude oil, U.S. oil prices sank below zero for the first time forcing the producers to return to the table and cobble together a rescue package to restore equilibrium to the market.

That the pact has held since then, despite one instance of dissent by the UAE in July 2021, is due to the relationship that Saudi Arabia, as de-facto OPEC leader, and non-OPEC supremo Russia have developed over the last five years working together as equals. To address the rift with the UAE, the group came to a consensus, after two weeks of occasionally testy diplomacy, granting the UAE a higher baseline to reflect rising capacity since October 2018, when the baselines were set, while Saudi Arabia and Russia took a higher reference of 11 million barrels per day each. The compromise has allowed for a more harmonious environment, which became evident as recent virtual ministerial meetings have become perfunctory affairs where decisions are rolled over month to month without drama.

OPEC+ laid out a phased plan tapering the cuts as demand and oil prices began the slow process of recovery, and, by the end of 2021, 70% of the barrels withdrawn from the market had been restored. With the global economy on track for growth, albeit unevenly across geographies, OPEC+ has ignored calls from the United States and major consumers like India to increase production beyond the agreed upon ceiling, sticking to a July 2021 blueprint for modest monthly increases of 400,000 b/d from August 2021 to September 2022. The OPEC+ ministers endorsed the agreement to continue with the increase through February when they last met on January 4. But the group, which now holds monthly meetings to allow close monitoring of the market, can push the timeline to the end of 2022 if warranted.

In August, OPEC will have a new secretary general in place, having elected Kuwaiti Minister of Oil Haitham al-Ghais to take over for Nigerian veteran Mohammad Sanusi Barkindo. Speaking shortly after he was elected unanimously by the 13 members of OPEC on January 3, Ghais was confident that the market was on the right track. “I think we have demonstrated through our unity and our cohesion over the years how successful this has been and how the market really has benefited from this cooperation between Opec-plus members,” he told specialist publication Energy Intelligence in an interview shortly after his election.

While OPEC producers like Saudi Arabia have managed to take full advantage of the price recovery and higher output and look forward to a budget surplus in 2022, other OPEC and non-OPEC producers have been unable to meet their higher quota allocations. This is partly a legacy of the slump in upstream investments in the two years that followed the 2014 oil price collapse and partly due to a less than attractive climate for foreign investors in some of the petrostates or to internal conflict as is the case with Libya. The energy transition and a shift in investor appetite to renewable energy projects in accordance with the growing drive to attain carbon neutrality has further crimped investment in new fossil fuel projects.

This has led to a divergence between producers that invested in capacity expansion in previous years and are able to increase output and those unable to produce at the October baseline let alone meet their higher quotas, because of production declines and low investment.

The divergence is expected to become even more pronounced in 2022 as producers will be able to open the taps without restriction in the closing months of the year, when demand is expected to recover to the pre-pandemic level. The International Energy Agency forecast in its January Oil Market Report that demand would exceed the pre-pandemic level to reach 99.7 mb/d by the final quarter of 2022, a 200,000 upward revision from its December 2021 outlook. On the supply side, “disruptions and production shortfalls are tempering growth expectations for 2022.” Producers party to OPEC+ restrictions (Libya, Venezuela, and Iran are exempt) delivered just 250,000 b/d of additional supply in December, some 790,000 b/d lower than the group’s target, according to the IEA. This was due to underproduction in Nigeria, Angola, and Malaysia, which the IEA stated faced technical and operational issues, while Russia pumped well below its quota for the first time since April 2020.

But significant supplies are expected from the United States, Canada, and Brazil, which the IEA estimates are set to produce at their highest ever annual levels this year. U.S. production is expected to average 17.7 mb/d, which would be a new record, from 16.7 mb/d in 2021. Led by U.S. gains, non-OPEC supply is expected to rise by 1.8 million in 2022.

Ecuador, Libya, and Nigeria are already ramping up production, while Russia and Saudi Arabia, the two biggest OPEC+ producers, could produce at record levels once the remaining cuts are fully unwound, according to the IEA. “In this case, global supply would soar by 6.2 million b/d on average in 2022 compared with a 1.5 million b/d rise in 2021.” The IEA expects this additional supply to lead to a surplus in the first quarter of 2022 and a tighter balance overall for the rest of the year.

The downside would be that, once output restrictions end and supply rises, OPEC+ spare production capacity, excluding Iran, would slip below 3 mb/d from around 5 mb/d. With inventories below pre-pandemic levels at the start of the year, the IEA predicted that the market “could be in for another volatile year in 2022.”

OPEC kingpin Saudi Arabia and the UAE are among a handful of producers that can ramp up production, but others would likely fall short. Nigeria and Angola are among OPEC producers that have underperformed, with output from Angola falling to a 17-year low, the IEA estimated.

But Saudi Energy Minister Prince Abdulaziz bin Salman said in November 2021 that the quotas should remain untouched to preserve “the stability of the agreement” rather than open the door to discussions each month on “who gets what.” Speaking during a news conference after the November OPEC+ meeting, he admitted that some countries had underperformed but said “no one will touch their allotment because they had a bad month here or maintenance.”

A number of industry analysts and officials, including Prince Abdulaziz, have been warning of a looming supply crunch by the end of this decade as the energy transition away from crude oil, coal, and even natural gas picks up, while demand for crude remains strong notwithstanding.

Prince Abdulaziz said in December 2021 that the decline in investments threatened to cut crude oil production by 30 mb/d by 2030. Saudi Aramco’s CEO, Amin Nasser, echoed similar concerns at the World Petroleum Congress in Houston that same month. Capital expenditure on oil and gas fell by 50% between 2014 and 2020, from $700 billion to $300 billion, he told the large industry gathering. “Consequently, supplies have started to lag. This is also hurting spare oil production capacity, which is declining sharply,” he said. “Yet this is happening against the backdrop of healthy demand growth.” Mounting pressure to stop all new oil and gas investments in the race to net-zero emissions would not deliver a smooth transition, he added. It was inconceivable to think that the global energy system could be transformed overnight and that investments of $115 trillion needed to deliver carbon neutrality could be made in less than 30 years, a reference to net-zero targets declared by a number of countries for mid-century. This sets the stage for a “chaotic energy transition” of a system still dominated by oil and gas, Nasser said.

Saudi Arabia, which puts its total oil output capacity at 12.5 mb/d, including the Neutral Zone it shares with Kuwait, is in the process of expanding its production capacity by 1 mb/d by 2027. The UAE is targeting the addition of 1 mb/d to take capacity to 5 mb/d by the end of the decade. Iraq has even higher ambitions to raise its capacity to 8 mb/d by the end of the decade from its officially declared capacity of just over 5 mb/d, but that is by no means certain due to capital constraints and the need for significant upgrades to its infrastructure and export facilities. The IEA in its January report lowered its estimate of Iraq’s sustainable production capacity by around 100,000 b/d to 4.8 mb/d due to export bottlenecks.

Both the UAE and Saudi Arabia are investing heavily in renewable energy and hydrogen projects to wean their economies off heavy reliance on revenue from hydrocarbons, but they are also betting on oil and gas to retain a dominant slice of the energy complex in coming decades, and this was reflected in their 2021 upstream spending allocations. “New and existing energy sources will need to operate in parallel for a long time,” Aramco’s Nasser said in Houston.

Not all producers have the financial clout of Saudi Arabia or the UAE, so even as the industry prepares for a revival as oil prices rise and demand recovers, analysts expect the investment shortfall to result in an imbalance with demand outstripping supply. “Upstream investment in the oil and gas sector was depressed for a second consecutive year in 2021 at $341 billion, nearly 25% below 2019 levels … Investment slumped by 30 percent in 2020. Global demand for oil and gas, meanwhile, has rebounded to near 2019 levels and is set to keep rising for several years,” the International Energy Forum, the energy producer-consumer platform, and IHS Markit, a global information provider, noted in a December 2021 joint report. “Upstream oil and gas investment levels will need to exceed pre-Covid levels over this decade” to restore market balance, according to the report.

The report suggested that among challenges that would make it difficult to meet “adequate investment levels this decade compared to decades past” were record levels of price volatility, changing government regulations, divergent long-term demand scenarios, and a lack of standardized environmental, social, and governance criteria, all of which were driving up costs and curtailing access to capital.

The trend to divest from oil and gas assets was already underway with nearly all the multinationals adopting net-zero or decarbonization policies, and this is likely to accelerate as a result of more ambitious commitments by governments and businesses in the wake of the 2021 United Nations Climate Change Conference, COP26, in Glasgow.

Commodities analyst Wood Mackenzie, in a press release summarizing the contents of its Global Upstream Outlook 2022, indicated that while the oil and gas sector would continue to rebound this year, “the positive outlook will be tempered by concerns about its future.” According to Wood Mackenzie, the upstream industry “must respond to the implications of the pledges made at COP26 and governments must set a course for the industry to follow.” It quoted Wood Mackenzie Vice President Fraser McKay as saying, “The upstream sector is going into 2022 facing ‘peak uncertainty’ – with record cash flows but increasing scrutiny.”

Adding to the uncertainty over future oil supply has been the sharp fall in the number of new discoveries in recent years. According to independent energy research and intelligence company Rystad Energy, global oil and gas discoveries in 2021 are “on track to hit their lowest full-year level in 75 years.” By the end of November 2021, a total of 4.7 billion barrels of oil equivalent was discovered and none announced in December. As a result, “The industry is on course for its worst discoveries toll since 1946,” and a drop from the 12.5 billion barrels of oil equivalent discovered in 2020.

All this points to a choppy period of volatility tinged with uncertainty over the course of the coronavirus pandemic and the possible impact of rising inflation in the world’s leading economies on demand and the value of the dollar, the main petroleum currency. The crisis over Ukraine, trouble in Kazakhstan (an OPEC+ member), continued sanctions against Iran, the intensifying war in Yemen, and delayed elections in Libya, among other geopolitical developments, all have the potential to throw the market off-kilter as the year progresses.