Morgan Stanley: OPEC+ production cut "especially critical now"

It's not often you get an OPEC+ meeting postponed just three days before its scheduled start. It's not a huge postponement, November 26 to November 30, but it does hint at some possible niggling-agro going on among the world's major oil producers!

Media reports hint it was a disgruntled Saudi Arabia that triggered the delay because it couldn't come to an agreement with several African countries about current production levels and possible production cuts. Most analysts expect the meeting will result in either another modest cut to OPEC+ production, or at the very least, an extension to the expiry of existing cuts.

As background to the current situation, OPEC+ has cut production twice in the last 12 months, by one million barrels per day in April, and two million barrels per day in November 2022. As the largest OPEC+ producer, much of these cuts will come from Saudi Arabia. The Saudis also announced a voluntary half-a-million-barrels-per-day cut in June, and although Russia reciprocated, the current meeting postponement possibly signals Saudi Arabia is tired of doing most of the heavy lifting.

Oil market dynamics

OPEC+ represents about 40% of global oil supply. My tip is this is less than you expected! The rest is made up of countries like Canada (6%), China (5%), and Brazil (3%). But, according to the US Energy Information Administration (EIA), the United States is the world's top oil producer with 21% of global production. This compares to Saudi Arabia's second place 13% (all data based upon 2022 production figures).

Indeed, in a recent research report, analysts at Morgan Stanley noted that production at non-OPEC, non-Russian producers has been rising steadily since the COVID-19 pandemic to help work against OPEC+'s cuts. This will no doubt be frustrating the Cartel's attempts to increase the price of crude oil.

non-OPEC, non Russia production is growing. Source: Morgan Stanley Research, "The Oil Manual", 21 November 2023

Morgan Stanley believes any decision by OPEC+ to further cut production is "especially critical now". This is because oil industry supply chains are recovering post-pandemic, and global economic growth has slowed and is likely to remain "muted" in 2024.

Further, as that pesky (if you're OPEC) non-OPEC supply continues to grow, to the tune of up to 1.4 million barrels per day over the next 12 months. This should be "enough to meet all global demand growth". Looking further out, non-OPEC production growth is likely to be sufficient to satisfy global oil demand in 2025 and also 2026.

Balancing act

Morgan Stanley suggests there's "little room in the oil market for additional OPEC oil". This means OPEC+ will need to balance the market or face lower prices in the short and medium term. Logically, this means cuts, but it can also mean extending the aforementioned voluntary cuts which were supposed to expire at the end of March 2024, to the end of 2024.

Such actions would be required to "balance" the crude oil market, and therefore maintain the price of Brent Crude Oil at Morgan Stanley's "mid-US$80/barrel" base case. But, there are two major risks to this default scenario according to Morgan Stanley.

OPEC+ spare capacity is up, market share is down. Source: Morgan Stanley Research, "The Oil Manual", 21 November 2023

The first is that, as OPEC+ cuts have taken effect, and as many member countries' supply chains have recovered, there has been a build-up in spare capacity of "close to 5 million barrels per day". Morgan Stanley notes this is now "close to the 25-year high (outside of COVID)".

It makes sense that many OPEC+ countries would love to pump more oil to supplement their coffers, just like other member countries including Iran and Venezuela, who are not subject to a quota. Morgan Stanley suggests this may be creating some "tension" among certain members of the Cartel.

The second risk sees OPEC+ decide to defend its market share which has been steadily falling over the past 12 months. Morgan Stanley says "history warns of the risk this eventually poses", and if OPEC+ fought to maintain or recover its market share, the downside potential for crude oil prices would be "significant".

Finally, Morgan Stanley notes that if nothing is done by OPEC+ to balance the market at this next meeting, the major threat to crude oil prices is a growing inventory build-up, which could send Brent Crude Oil to US$70/barrel.