OPEC and its non-OPEC allies reached a compromise agreement for a gradual increase in oil production of 500,000 barrels per day beginning in January 2021. The 23 members of the alliance will meet monthly to assess market conditions and tweak production levels up or down if necessary. The deal was welcomed by the market and oil prices rose to their highest level since March to just short of $50 per barrel for international marker Brent crude oil futures on December 4, a day after the OPEC+ alliance concluded its deliberations.

Under an April accord that followed a bruising price war between Saudi Arabia and Russia, the OPEC+ producers agreed to slash production by 9.7 million barrels per day to rebalance a market battered by the coronavirus pandemic. The restrictions were to be phased out gradually starting in June. All went according to plan initially as lockdowns were eased and demand picked up in Asia, allowing for the implementation of the first phase to take reductions down to 7.7 mb/d. The second phase was due in January to take the overall cut down to 5.8 mb/d. But with lukewarm demand and high oil inventories weighing on the market, the expectation was that OPEC+ would freeze production for the first three months of next year, a move believed to have been favored by OPEC kingpin Saudi Arabia.

The return of Libyan oil to markets in recent months with current production at 1.3 mb/d after sinking to near zero in the summer was another factor to consider along with the possible return of some Iranian oil in the new year should the incoming U.S. administration of President-elect Joseph R. Biden Jr. ease sanctions on Iran. Libya is not party to the production curbs and there are no guarantees that a tenuous cease-fire between warring factions will survive and allow for a return to higher production levels.

The talks did not go as smoothly as expected and the OPEC meeting was pushed back by two days to allow time for a compromise deal that would satisfy a reluctant Russia and the United Arab Emirates, which reportedly insisted on full compliance and compensatory cuts by all quota-busting members before it would sign up to a deal.

The compromise agreement allows members of the alliance that have not adhered to their quotas time to adjust their production levels gradually through the first quarter of 2021. This is an acknowledgement of the special circumstances of countries like Iraq, which has not been in full compliance and would have been called upon to cut an additional 300,000 b/d to meet its quota. Given the parlous state of the Iraqi economy, the decision is welcome relief for Baghdad.

As a result, what Saudi Energy Minister Prince Abdulaziz bin Salman called a “drip by drip” approach will be balanced out by the additional cuts to be made by Iraq and others who have produced above their allocations, so the increase will do little to upset the market’s equilibrium or an expected drawdown of oil inventories in the first quarter.

Prince Abdulaziz said in the closing news conference that the market should credit the OPEC+ alliance with success in draining a total 1.6 billion barrels from the market since May rather than focus on reports of rifts within the group. “If you want to work with 23 countries, you have to be very congenial to the idea of flexibility,” he said, adding that there was a need to deliver an agreement that addressed both the market’s needs and those of the participants. The group had “delivered 99.5% of what is the biggest cut in history,” he told journalists and analysts.

Although the Saudi energy minister played down reports of disagreements within the broad alliance, he admitted that he had at one point “thrown in the towel,” a reference to his role as chair of the OPEC and OPEC+ ministerial meetings but that he had relented and agreed to stay on in the role. The Saudi minister has worked closely with Alexander Novak, formerly Russia’s energy minister who has recently been promoted to deputy prime minister. They both sit on the Joint Ministerial Monitoring Committee, which monitors compliance and makes recommendations to the full ministerial conference. Prince Abdulaziz said the Joint Ministerial Monitoring Committee would meet monthly to assess market conditions before deciding whether to tweak production in response to market developments.

Novak, who said his country will get a 125,000 b/d supply boost under the new agreement, explained that the decision to meet monthly meant the group would be able to take into account positive or negative factors and determine what action is needed beyond January. He also announced plans to visit Saudi Arabia for a face-to-face meeting with Prince Abdulaziz in January in what appears to be an effort to lay to rest perceptions that the two countries are not fully aligned on oil policy.

Citigroup said in a note to clients that it expects the 1.9 mb/d to return to markets by April 2021 barring negative surprises to the demand side. This will lead to “a lower, but still hefty annual stock draw for 2021 on the order of 2 mb/d.”

Oil prices have recovered from the April slump, when U.S. oil prices briefly fell below zero, and were rising even before the OPEC+ meeting on expectations that coronavirus vaccines are due to be rolled out and on signs of a demand recovery in China and India. But the overall picture is of uneven growth as a new wave of the pandemic has swept across the United States and much of Europe. As a result, OPEC in November revised down its demand forecast by 300,000 b/d and now expects an overall demand reduction of 9.8 mb/d in 2020 to just above 90 mb/d, which is down by 10 mb/d since January. Although it expects a bounce back to 96 mb/d in 2021, this is still far short of the pre-pandemic demand forecast of 102 mb/d.

The OPEC+ alliance has managed to spring a surprise that will keep the market guessing in the months ahead and stamp out dissent within its ranks, at least for the time being. Much will depend on the commitment of all parties to abide by their new allocations, because, while some leakage can be expected, the supply-demand balance remains too tight and can flip either way.