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Brent, the global crude oil benchmark will end the year 2020 at about US$50/b. Compared to its price level at the start of the year, that’s a fall of some 17%. But absolutes like that do not tell the story of the extraordinary year that was 2020. In between January and December, an oil price war was started, crude oil prices plunged as the coronavirus pandemic swept across the globe. The WTI benchmark briefly fell into negative pricing and the OPEC+ club agreed to a historic supply agreement that slashed nearly 10 million barrels per day of supply from the global market. All of that led to a gradual recovery in crude oil prices, with Brent doubling from its nadir of US$24/b in mid-April 2020. The question now is: what happens in 2021?
There are a lot of assumptions that need to underpin any prediction of crude price trends. And, therefore, it is best to address those before making any pronouncements.
First, demand. With Covid-19 vaccinations programmes rolling out, it is very likely that the global GDP will return to some semblance of normality by mid-2021. Planes and trains will somewhat start flying regularly again, while the travel and hospitality sector will return. In some parts of the world, this has already started to happen. In China, where the pandemic originated, the domestic economy has been pretty much restored and oil demand is now exceeding pre-Covid levels. Other Asian economies are following suit, as the pandemic comes under control. At some point in 2021, the full opening of international borders will follow suit. But there is a new wrinkle in the story. Two new variants of Covid-19 have been discovered recently in the UK, with both thought to be nearly twice as infectious. Travel originating from the UK was blocked as governments panicked over importing the new variants, even as inoculations were rolled out worldwide. So any progress in restoring the global economy and oil consumption trends, could be derailed by ongoing mutations in the virus, especially if any newer variants prove to be resistant to the current vaccines that have been developed.
But, on balance, 2021 should be a year of regrowth, with oil consumption following suit. Depending on the intensity of recovery, world oil demand could rise by between 5-7 mmb/d. That won’t be enough to offset the 9 mmb/d decline in 2020, but will do enough to drive crude oil prices higher. Assuming that the supply situation does not break down.
Alas, that is a possibility. The year 2020 proved to be a year of identity crisis for OPEC+, the producer club that controls over 50% of global crude oil production. After several years of beneficial cooperation that allowed crude prices to recover to US$60/b levels, a spat between OPEC+’s two giants – Saudi Arabia and Russia – triggered a price war to devastating consequences. Bruised egos aside, the immediate aftermath did not prevent the two countries coming together to announce the largest crude oil supply quota deal ever in April. But the scars still remain, driving a wedge between the Saudis and the Russians despite their mutual dependency. Grouses over the quota allocations have also made fresh wounds: culprits like Nigeria and Iraq continue to be blamed for flouting their targets, as was the UAE, formerly a loyal supporter in OPEC’s Saudi faction, which has publicly threatened to leave the group.
All of this has implications for the crude oil supply trend in 2021. In November, it was presumed that OPEC+ would postpone the taper of its supply deal by several months, citing ‘fragility’ of demand. The opposite happened. At a fraught bi-annual meeting, OPEC+ will now switch to a monthly review of quota revisions, allowing for a 500,000 b/d increase in overall production in January and (presumably) increases of the same amount for February and March. But as much as OPEC+ can do, there are factors beyond its control. Libya, an OPEC member does not have any formal quotas, an exception granted as it recovers from a prolonged civil war with production now returning to full strength. US shale is also starting to recover in selected areas. The refining industry, especially in Europe may have remade the balance of fuel supply and demand in ways that are difficult to predict right now.
The picture emerging for 2021 in the short term, is for a demand-led recovery for crude prices, with the main challenge being for supply to throttle its own recovery to keep pace but not exceed the demand curve. If OPEC+ can hold together to continue to play this role, then crude oil benchmarks should stay within the US$50-60/b range in 2021. That won’t be enough to appease everyone, but it should be good enough to keep the industry chugging along and restart some upstream investments. It could be argued that this 2021 prediction may be too optimistic; but we need to move forward from all of the pessimism in 2020 at some point. At least that’s the plan.
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Source: U.S. Energy Information Administration, Short-Term Energy Outlook (STEO)
In its January 2020 Short-Term Energy Outlook (STEO), the U.S. Energy Information Administration (EIA) forecasts that annual U.S. crude oil production will average 11.1 million b/d in 2021, down 0.2 million b/d from 2020 as result of a decline in drilling activity related to low oil prices. A production decline in 2021 would mark the second consecutive year of production declines. Responses to the COVID-19 pandemic led to supply and demand disruptions. EIA expects crude oil production to increase in 2022 by 0.4 million b/d because of increased drilling as prices remain at or near $50 per barrel (b).
The United States set annual natural gas production records in 2018 and 2019, largely because of increased drilling in shale and tight oil formations. The increase in production led to higher volumes of natural gas in storage and a decrease in natural gas prices. In 2020, marketed natural gas production fell by 2% from 2019 levels amid responses to COVID-19. EIA estimates that annual U.S. marketed natural gas production will decline another 2% to average 95.9 billion cubic feet per day (Bcf/d) in 2021. The fall in production will reverse in 2022, when EIA estimates that natural gas production will rise by 2% to 97.6 Bcf/d.
Source: U.S. Energy Information Administration, Short-Term Energy Outlook (STEO)
EIA’s forecast for crude oil production is separated into three regions: the Lower 48 states excluding the Federal Gulf of Mexico (GOM) (81% of 2019 crude oil production), the GOM (15%), and Alaska (4%). EIA expects crude oil production in the U.S. Lower 48 states to decline through the first quarter of 2021 and then increase through the rest of the forecast period. As more new wells come online later in 2021, new well production will exceed the decline in legacy wells, driving the increase in overall crude oil production after the first quarter of 2021.
Associated natural gas production from oil-directed wells in the Permian Basin will fall because of lower West Texas Intermediate crude oil prices and reduced drilling activity in the first quarter of 2021. Natural gas production from dry regions such as Appalachia depends on the Henry Hub price. EIA forecasts the Henry Hub price will increase from $2.00 per million British thermal units (MMBtu) in 2020 to $3.01/MMBtu in 2021 and to $3.27/MMBtu in 2022, which will likely prompt an increase in Appalachia's natural gas production. However, natural gas production in Appalachia may be limited by pipeline constraints in 2021 if the Mountain Valley Pipeline (MVP) is delayed. The MVP is scheduled to enter service in late 2021, delivering natural gas from producing regions in northwestern West Virginia to southern Virginia. Natural gas takeaway capacity in the region is quickly filling up since the Atlantic Coast Pipeline was canceled in mid-2020.
Just when it seems that the drama of early December, when the nations of the OPEC+ club squabbled over how to implement and ease their collective supply quotas in 2021, would be repeated, a concession came from the most unlikely quarter of all. Saudi Arabia. OPEC’s swing producer and, especially in recent times, vocal judge, announced that it would voluntarily slash 1 million barrels per day of supply. The move took the oil markets by surprise, sending crude prices soaring but was also very unusual in that it was not even necessary at all.
After a day’s extension to the negotiations, the OPEC+ club had actually already agreed on the path forward for their supply deal through the remainder of Q1 2021. The nations of OPEC+ agreed to ease their overall supply quotas by 75,000 b/d in February and 120,000 b/d in March, bringing the total easing over three months to 695,000 b/d after the UAE spearheaded a revised increase of 500,000 b/d for January. The increases are actually very narrow ones; there were no adjustments for quotas for all OPEC+ members with the exception of Russia and Kazakshtan, who will be able to pump 195,000 additional barrels per day between them. That the increases for February and March were not higher or wider is a reflection of reality: despite Covid-19 vaccinations being rolled out globally, a new and more infectious variant of the coronavirus has started spreading across the world. In fact, there may even be at least of these mutations currently spreading, throwing into question the efficacy of vaccines and triggering new lockdowns. The original schedule of the April 2020 supply deal would have seen OPEC+ adding 2 million b/d of production from January 2021 onwards; the new tranches are far more measured and cognisant of the challenging market.
Then Saudi Arabia decides to shock the market by declaring that the Kingdom would slash an additional million barrels of crude supply above its current quota over February and March post-OPEC+ announcement. Which means that while countries such as Russia, the UAE and Nigeria are working to incrementally increase output, Saudi Arabia is actually subsidising those planned increases by making a massive additional voluntary cut. For a member that threw its weight around last year by unleashing taps to trigger a crude price war with Russia and has been emphasising the need for strict compliant by all members before allowing any collective increases to take place, this is uncharacteristic. Saudi Arabia may be OPEC’s swing producer, but it is certainly not that benevolent. Not least because it is expected to record a massive US$79 billion budget deficit for 2020 as low crude prices eat into the Kingdom’s finances.
So, why is Saudi Arabia doing this?
The last time the Saudis did this was in July 2020, when the severity of the Covid-19 pandemic was at devastating levels and crude prices needed some additional propping up. It succeeded. In January 2021, however, global crude prices are already at the US$50/b level and the market had already cheered the resolution of OPEC+’s positions for the next two months. There was no real urgent need to make voluntary cuts, especially since no other OPEC member would suit especially not the UAE with whom there has been a falling out.
The likeliest reason is leadership. Having failed to convince the rest of the OPEC+ gang to avoid any easing of quotas, Saudi Arabia could be wanting to prove its position by providing a measure of supply security at a time of major price sensitivity due to the Covid-19 resurgence. It will also provide some political ammunition for future negotiations when the group meets in March to decide plans for Q2 2021, turning this magnanimous move into an implicit threat. It could also be the case that Saudi Arabia is planning to pair its voluntary cut with field maintenance works, which would be a nice parallel to the usual refinery maintenance season in Asia where crude demand typically falls by 10-20% as units shut for routine inspections.
It could also be a projection of soft power. After isolating Qatar physically and economically since 2017 over accusations of terrorism support and proximity to Iran, four Middle Eastern states – Saudi Arabia, Bahrain, the UAE and Egypt – have agreed to restore and normalise ties with the peninsula. While acknowledging that a ‘trust deficit’ still remained, the accord avoids the awkward workarounds put in place to deal with the boycott and provides for road for cooperation ahead of a change on guard in the White House. Perhaps Qatar is even thinking of re-joining OPEC? As Saudi Arabia flexes its geopolitical muscle, it does need to pick its battles and re-assert its position. Showcasing political leadership as the world’s crude swing producer is as good a way of demonstrating that as any, even if it is planning to claim dues in the future.
It worked. It has successfully changed the market narrative from inter-OPEC+ squabbling to a more stabilised crude market. Saudi Arabia’s patience in prolonging this benevolent role is unknown, but for now, it has achieved what it wanted to achieve: return visibility to the Kingdom as the global oil leader, and having crude oil prices rise by nearly 10%.
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