OPEC’s pricing power increased over the past years as the U.S. energy policy supported alternative and renewable fuels while inhibiting fossil fuel production and consumption. In my November 6 article on crude oil, I wrote:
Crude oil has declined to a level that could be compelling, given the geopolitical landscape.
Nearby NYMEX crude oil futures were at the $81.94 per barrel level on November 6. The price was around the $74 level in early December as seasonality and the potential for more OPEC output weighed on the price.
OPEC’s mission
OPEC, the international oil cartel, aims to adjust worldwide supplies via its production policies to maximize returns for its members and investors in the petroleum market. OPEC’s mission statement reflects its goals:
Since the cartel’s production policies determine worldwide supplies, it has significant pricing power in the international petroleum markets.
In 2016, Russia began cooperating with the cartel. While not an official member, the Russian oil minister is one of the most influential parties deciding on output quotas, as the cartel depends on continued Russian cooperation.
At the latest meeting, OPEC gained another member. Brazil, the leading South American economy, produces around 3.5 million crude oil barrels daily and will become an official voting member in January 2024.
While OPEC has thirteen official members in 2023, rising to fourteen in 2024, the production decisions are often a function of negotiations between Riyadh, Saudi Arabia, and Moscow.
OPEC problems- Saudis want more participation
The delay of the biannual meeting from November 26 to November 30 indicated a lack of consensus on 2024 production quotas. Saudi Arabia had been shouldering the bulk production cuts and wanted more cooperation and participation from the other cartel members. The November 30 meeting ended with no material change in output policies but a voluntary system of additional cuts to stabilize prices. The Saudis and Russians pledged to continue their cuts over the coming months. Saudi Arabia requires crude oil at $80 per barrel to balance its domestic budget.
The oil futures market did not move much, as the production quotas will continue without further output reductions.
Russia and Iran need petroleum revenues
Cheating on production quotas has always been problematic for the cartel, as the membership operates on a highly dubious honor system. The economic reality of the geopolitical landscape means Russia and Iran require more crude oil revenues.
Russia and Iran are at the center of the international stage with wars in Ukraine and the Middle East. Sanctions have weighed on Moscow and Teheran, making petroleum sales critical for revenue flows.
Russia and Iran have likely sold additional petroleum to China and other allies at discounts and quantities above their respective production quota levels.
We can’t discount the impact of wars in Ukraine and the Middle East
Over the past years, OPEC+ has cited economic weakness in China, the world’s most populous and second-leading economy, as the reason for production cuts. Meanwhile, since Russia invaded Ukraine in early 2022, crude oil has become an economic weapon for Moscow against “unfriendly” countries supporting Ukraine. The war in Ukraine initially sent prices to the highest level since 2008 at above $130 per barrel, which has kept a bid under the oil futures market.
Meanwhile, the war in Israel is another factor to watch for the coming year. OPEC members have lined up in opposition to Israel’s response to the October 7 terrorist attack. The situation in Israel and the Middle East has deteriorated to the worst since the 1973 Yom Kippur war. In the 1970s, the Arab countries embargoed crude oil to the U.S., causing prices to soar.
The U.S. now produces 13.2 million barrels per day, a record level. However, any embargo or rising hostilities near the Persian Gulf could cause sudden upside spikes in oil prices. Even with U.S. production at high levels, the Biden administration sold crude oil from the U.S. Strategic Petroleum Reserve in 2022 and 2023 to control prices after the Ukraine-inspired price spikes.
The U.S. could create a bottom for the energy commodity- Buying the dip in late 2023, leaving room to add at lower levels
The U.S. SPR stood at over 600 million barrels in late 2021. At the end of November 2023, it was over 40% lower at 351.6 million barrels.
On October 18, 2022, the Biden administration told markets it “intends to repurchase crude oil for the SPR when prices are at or below above $67-$72 per barrel.” While WTI crude oil prices fell to or below the administration’s target range in December 2022 and March, May, June, and July 2023, the Department of Energy only repurchased around four million barrels after selling more than a quarter of a million SPR barrels.
The administration is a lurking buyer under the market, with nearby January WTI crude oil prices at around the $74 per barrel level on December 4.
The three-month chart of January NYMEX crude oil futures prices shows technical support at the November 16, $72.37 low, just above the high end of the administration’s target buying zone.
The latest OPEC meeting signaled discord between Saudi Arabia, which is looking for more cooperation and participation with production cuts, and other members looking to sell more petroleum to increase revenues. With a long history of cheating on stated quotas, the current “voluntary” production cuts may not result in less production. However, bringing Brazil into the cartel will strengthen OPEC’s worldwide position in the long term, and the U.S. plans to replace its SPR are factors that will prevent the cartel’s discord from sending prices significantly lower. Moreover, the continuing wars and increasing hostilities in Eastern Europe and the Middle East could cause sudden price spikes over the coming weeks and months. Therefore, crude oil could be in the buy zone under the $80 per barrel level. However, the volatile energy commodity can move far below levels that fundamental supply and demand dynamics dictate, as we witnessed in 2020 when the global pandemic sent NYMEX futures into negative territory. The same holds on the upside, as in 2022, when prices exploded over $130 per barrel. Therefore, when considering a long position in crude oil or oil-related assets, leave plenty of room to add on further declines as picking bottoms can be dangerous.
OPEC has a cooperation problem, but the U.S. plans to replace the SPR, and the geopolitical turmoil could bail the cartel out in 2024.
On the date of publication, Andrew Hecht did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
