OPEC+ sticks to its guns for March despite capacity, geopolitical concerns

OPEC and its allies on Feb. 2 decided to persist with another modest hike in crude production quotas for March, in the face of surging oil prices and rising geopolitical market risks.

In a Groundhog Day meeting that wrapped up in a record low 16 minutes, the OPEC+ alliance arrived at the same conclusion as it has in the previous seven months -- no additional supplies beyond the previously agreed 400,000 b/d monthly tapering of its pandemic output cuts were needed. Any difficult decisions over the group's shrinking spare capacity and sanctions challenges were kicked down the road.

Oil prices, which have hit a seven-year high in recent days, rose sharply in the wake of the meeting, with front-month ICE Brent futures climbing to an intraday high of $90.52/b. But by 1628 GMT, the gains were erased, with Brent trading at $88.53/b, down 64 cents from the previous settlement after a smaller-than-expected draw in US oil inventories.

This decision also comes amid a much tighter physical oil market, with inventories shrinking and the Brent crude complex in its steepest backwardation on record, nearing $3/b between February and March contracts, according to Platts data.

Backwardation traditionally points to a market in significant deficit with the need for more supply or less demand to rebalance it.The OPEC+ alliance will next meet on March 2 to decide on April output levels.

Spare capacity doubts

The 23-country OPEC+ alliance, which controls about half of global oil production, is aiming to completely wind down the historic 9.7 million b/d production cuts it instituted during the worst of the pandemic in May 2020 by late 2022. By drip-feeding the market by 400,000 b/d each month, the group is attempting to balance supplies with the expected rise in oil demand.

But in the past few months, the market's focus has increasingly homed in on the alliance's dwindling production capacity.

Many of its members, such as Nigeria, Angola and Malaysia, have struggled to hit their quotas over recent months, casting doubt on whether the alliance can provide the barrels it has promised.

The 19 OPEC+ countries with quotas underperformed their production targets by 832,000 b/d in December, according to an analysis prepared for the group's technical committee and seen by S&P Global Platts. If this trend persists, the oil market is likely to swiftly move into deficit and push oil prices even higher, at a time of soaring inflation.

"Capacity constraints will become more limiting by May, when 96% of the world's remaining 1.8 million b/d of spare capacity will reside in Saudi Arabia and the UAE," said Paul Sheldon, Platts Analytics' chief geopolitical adviser. "A thinning market buffer increases the importance of Iran nuclear talks, as well as supply risks from Russia, Libya and elsewhere."

But OPEC+ delegates told Platts that there has been no consideration of countries with spare capacity stepping in to fill the supply gaps -- a move that its poorer members would see as encroachment on their market share.

"They decide based on actual supply/demand" and not geopolitics, a delegate said.Another shrugged off the shortfalls as "a temporary situation."

"Countries will recover and meet their quotas," the delegate said, adding that the maintenance and technical issues were some of the reasons for the fall in output of some of its members.

Another tricky decision will be in a few months' time, when from May 2022, under a deal agreed to in July 2021, Saudi Arabia, Russia, the UAE, Iraq and Kuwait will hold higher production baselines from which quotas are determined.

"Doing something else now is complicated since the new baselines come into effect in May; and any changes need to be adjusted from total cuts," the second delegate added. "Also, it would be counterintuitive to the current geopolitical picture."

Russia in the spotlight

Fears of a confrontation between the US-led NATO powers and Russia over the future of Ukraine have created a volatile backdrop over the last few weeks. If western countries apply sanctions on Russia, the world's second largest-producer behind the US, the consequences for the oil market could be cataclysmic.

But OPEC+ delegates told Platts there was no discussion of the issue.

Russian Deputy Prime Minister Alexander Novak, who represents the country at OPEC+ meetings, said the group reviewed various oil market outlooks, but focused most of their deliberations on the continued impact of coronavirus infections on global economic activity.

"We note a recovery, including in air travel, in the consumption of petroleum products in the world," he said in an interview with the Rossiya 24 television network. "The situation is certainly different everywhere, so we need to keep abreast and monitor the situation, which, in principle, we do on a monthly basis under our agreement."

Russia is currently the top OPEC+ producer, pumping 10.01 million b/d in December, according to the latest Platts survey of the group's output.

Russian spare production capacity has shrunk significantly over the last year, surprising many on the market.

Many of its oil companies have already brought most of their idled production back on stream, and cold weather capped some of Russia's output increases in the past few months.

Platts Analytics expects Russia to run out of its sustainable crude production capacity of around 10.5 million b/d, by the end of the second quarter.

"Production growth in 2022 will not keep pace with its quota increases under the current framework deal," it said in a recent note. "We forecast a new drilling program and warmer weather will allow crude production to grow by 325,000 b/d by end 2022."