Global oil prices have fallen back from their highest level in more than a year as demand uncertainty erased some of the gains that followed the early March meeting of OPEC and its Russian-led allies, the OPEC+ group of oil producers. OPEC+ agreed on March 4 to hold output steady into April, when it is due to meet again to review market conditions. The question before ministers is whether they can release more oil, and by how much, without tipping the market into a surplus should the demand recovery falter.

OPEC production fell to a 4-month low in February, largely because Saudi Arabia took on the burden of cutting 1 million barrels per day of its own production unilaterally to speed up the drawdown of global oil inventories that had built up in 2020. The Middle East Economic Survey estimates that OPEC’s output fell by 400,000 b/d as the Saudi cuts came into effect. It put February production by the 13 OPEC members at 25.05 mb/d, the lowest since October 2020, and slightly below the “call” on, or demand for, OPEC oil for the first quarter. Global oil supply overall fell by 2 mb/d on a combination of the Saudi cut and U.S. cold-weather power outages that knocked out production in Texas.

A number of analysts have cautioned that the market might overheat if the OPEC+ producers keep output tight just when demand growth returns as a new U.S. fiscal stimulus and a gradual reopening of the global economy unleash pent up consumer demand.

OPEC+ agreed on a phased monthly increase of oil production starting in January. However, the group decided to hold production steady in March rather than continue to ease restrictions, which sent prices sharply higher. Global benchmark Brent blend crude rose above $70 per barrel, its highest level since the start of the coronavirus pandemic in early 2020.

The Paris-based International Energy Agency’s demand forecast is slightly more bearish than OPEC’s estimates. In its March Oil Market Report, the IEA projects world demand to recover by 5.5 mb/d in 2021, while OPEC, in its monthly report, forecasts an increase of 5.9 mb/d. This level of demand would represent a 60% recovery of volumes lost in 2020 to the pandemic, the IEA notes.

Although the market’s structure, whereby prompt prices are higher than forward values, reflects tighter supply and discourages further stock building, other factors contributed to the price rally that peaked in early March. Frequent attacks by Houthi rebels in Yemen against Saudi energy facilities have raised the stakes in the Middle East and added a risk premium. The Houthis, who are battling a Saudi-led coalition in Yemen, launched a drone and missile attack against Saudi Arabia’s Ras Tanura oil export terminal on March 8. Although there was no significant damage or loss of life, the attack highlighted the risk of potential disruption to global supplies. Another attack targeted a Riyadh oil refinery on March 18, again without causing serious damage.

On the minus side, the high level of spare production capacity available as a result of the 9.7 mb/d reduction that came into effect in April 2020 creates a bearish dynamic and may keep a lid on prices. The IEA estimates that spare capacity held by OPEC alone, excluding Iran, stood at 7.7 mb/d in February. Saudi Arabia holds the bulk of global spare capacity and has previously used its position as the de facto central bank of oil to bend other producers party to the agreements to its will.

This time around, however, the kingdom has erred on the side of caution. It extended the unilateral cut by an extra month to the end of April while allowing Russia and Kazakhstan small increases in February and March, just enough to keep them on side without upsetting market fundamentals. Were it not for the Saudi reduction, global inventories would have risen, making it harder to balance the market, which has taken another hit from delayed vaccine rollouts, new lockdowns, and an uneven global economic recovery.

Prince Abdulaziz bin Salman, the Saudi energy minister, again urged caution and vigilance when he addressed fellow ministers at the March 4 virtual OPEC+ gathering. “The uncertainty around the pace of recovery has not receded and we have learned in the course of last year the difficulty of making hard predictions in such an unpredictable environment,” he said. “Against this background, and at the risk of sounding like a stuck record, I would once again urge caution and vigilance. … Before we take our next step forward, let us be certain the glimmer we see ahead is not the headlight of an oncoming express train,” he added.

OPEC sources expect the kingdom to hold back from releasing the full 1 mb/d in one go, opting instead to bring on some production gradually starting in May. Prince Abdulaziz suggested as much, saying that the proper course of action was “to keep our powder dry and to have contingencies in reserve to insure against any unforeseen outcomes.”

The dilemma for both OPEC and Russia is managing a volatile and unpredictable market without allowing prices to rise to levels that would encourage growth in U.S. shale and other higher-cost production. There is no immediate danger of that at present as U.S. oil producers, stung by the oil price collapse of 2020, are capping investments and reducing drilling activity. The IEA in its Oil Market Report projects U.S. production will slide by 180,000 b/d in 2021 after a 600,000 b/d fall in 2020. These numbers prompted Prince Abdulaziz to declare that the days of “drill, baby, drill,” the U.S. shale mantra at the time of rapid production growth, were over.

Despite weaker U.S. production growth and a high level of compliance by the OPEC+ members, the IEA poured cold water on suggestions by leading financial institutions of a “commodities supercycle.” It noted that there was still too much oil slushing around, with inventories lingering around 110 million barrels higher than at the start of the pandemic, although OPEC+ is still withholding 8 mb/d of supply. The IEA does not expect demand to recover fully to pre-pandemic levels before 2023.

Beyond the immediate term, OPEC producers, specifically in the Middle East, stand to regain some of the market share lost to U.S. shale and other non-OPEC producers, in the medium term. But the demand for OPEC’s oil by 2026, at an estimated 30.8 mb/d, from 27.3 mb/d in 2021, would still be below the 2017 level, according to the IEA’s medium-term forecast.

Call on OPEC to Remain Below 2017 Levels Despite Steady Growth to 2026 (mb/d)

The IEA expects demand to outpace supply growth by 2026, assuming no changes to government policies that could speed up the transition away from oil. In its base case scenario, the IEA projects oil demand rising to 104 mb/d by 2026, an increase of 4% from 2019 levels, driven almost entirely by Asian demand growth. At these levels, there would be no demand peak before the end of the decade. “For the world’s oil demand to peak any time soon, significant action is needed immediately to improve fuel efficiency standards, boost electric vehicle sales, and curb oil use in the power sector,” Fatih Birol, the IEA’s executive director, said in presenting the outlook.

However, government policy interventions, combined with increased teleworking and less air travel following the coronavirus pandemic, as well as tighter energy efficiency measures, could reduce oil consumption by 5.6 mb/d by 2026 and global demand would never return to pre-pandemic levels.

To meet the anticipated growth in oil demand in the base case scenario, the world would need 10 mb/d of additional supply by 2026 with the Middle East expected to supply half of the total. However, the sharp reduction in upstream investments in 2020, which declined by 30% in response to the pandemic-induced slump, raises the possibility of a mismatch between supply and demand by the end of the forecast period. The IEA report expects global oil production capacity to increase by 5 mb/d by 2026, so demand would be met by tapping into spare capacity, which would shrink to 2.4 mb/d, most of it in Saudi Arabia. Should Iran return to the market if sanctions are lifted, that would add another 1.7 mb/d of capacity.

Although all of this is subject to revision, depending on how strongly government policies and net zero emissions targets are reached, the IEA noted it was confident in saying that gasoline consumption had peaked and will never come back to the 2019 level.

The April 1 OPEC+ meeting will have to consider the immediate and longer-term impact of its market management policies if it wants to avoid the pitfalls that have contributed to oil price volatility in the past. Allowing oil prices to rise too quickly would accelerate the drive to decarbonize the global economy and dampen demand growth in countries like India, which are more sensitive to oil price hikes than other major consuming countries. Low oil prices, on the other hand, deter investment in greenfield projects that take years to become operational, thereby setting the stage for potential supply gaps and a renewed cycle of oil price volatility.

In times of crisis, markets need a steady hand to avoid pitfalls and the consequences of hasty decisions. Saudi Arabia and Russia appear to be on the same page now after putting a damaging tussle for market share behind them. They have managed, through a coordinated policy born of necessity, to avoid the threat of the collision that Prince Abdulaziz still fears may derail their hard-won efforts.