Energy prices are hovering above the $75 level after OPEC and its allies could not reach a key deal on their oil output policy last week, amid rising tensions between Saudi Arabia and the UAE.
Crude prices are seeing some volatility after an initial spike, but retreated slightly on Monday. Brent futures slipped 0.11% to $76.09 per barrel, while U.S. crude futures dipped 0.13% to $75.06 per barrel.
The energy alliance, often referred to as OPEC+, will meet again on Monday after failing to reach a deal twice last week.
Without a deal, oil prices could surge and threaten to derail a frail economic recovery. If talks fall through, there could also be a price war — though analysts do not think the latter scenario is likely.
The United Arab Emirates blocked a deal to increase oil output and extend the expiry of the group’s broader production supply agreement to the end of next year, according to Reuters. The UAE said the extension should be conditional on revising the so-called baseline, which determines how much a country is allowed to pump.
Both Brent and U.S crude shot up more than 2% to above $75 per barrel on Thursday, reaching highs not seen since 2018. The deal first fell through on Thursday, and a second meeting on Friday failed to see any breakthrough as well.
Oil prices have surged more than 45% in the first six months of 2021, with demand rising as global economies reopened.
Why oil prices spiked
The UAE — a long-time ally of OPEC’s leader Saudi Arabia — objected to the deal twice last week, according to Reuters.
The deal includes an agreement to increase oil output gradually, while at the same time, extending the duration of broader cuts that the group agreed to in 2021.
Last year, to cope with lower demand as the Covid crisis hit and people travel less, OPEC+ agreed to curb output by almost 10 million barrels per day from May 2020 to the end of April 2022.
At last week’s meeting, OPEC kingpin and non-OPEC leader Russia also proposed extending the duration of cuts until the end of 2022, according to Reuters.
Top producers Saudi Arabia and Russia had reached a preliminary agreement, which would in principle increase supply by 400,000 barrels per day from August to December 2021 in order to meet rising demand, Reuters reported, citing unnamed sources.
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What the UAE wants
The UAE “unconditionally” supports an increase in production, its minister of energy and infrastructure told CNBC on Sunday.
“The issue is putting a condition on that increase, which is the extension of the agreement,” Suhail Al Mazrouei told CNBC’s Hadley Gamble, adding that the current proposal simply “wasn’t a good deal” for the UAE.
At the heart of the matter is the baseline. Production cuts or increases are measured against a baseline — the higher that number, the more oil a country is allowed to pump.
The UAE wants its baseline to be revised before extending those cuts till end of 2022, because it wants to produce more than it is now allowed based on the quota of its current baseline.
The current baseline set for the UAE was taken from October 2018, when it was producing around 3.2 million barrels a day. Last year, the number jumped to 3.8 million barrels per day.
The UAE argues that the frame of reference for the 2022 extension shouldn’t be taken from four years ago.
“Now we think that linking the extension of the agreement for a reference that goes back to 2018, and for a period that starts from 2022, is just not realistic, because this is four years,” Al Mazrouei told CNBC.
“That is totally unfair.”
The UAE has spent billions investing in its oil production capacity, seeking to ramp up output. However, countries will only be able to renegotiate their baselines at the end of the current production deal — which now Saudi Arabia and Russia wants to extend.
Why it matters
If OPEC+ fails to reach a deal to increase output, prices could skyrocket.
Rising oil prices could destroy demand growth at some point, and risk the recovery of economic growth just as several economies are starting to reopen after Covid vaccinations rise.
A “bullish” outcome for oil prices would be if the group sticks to the original deal — with no production increase, according to Helima Croft, head of global commodity strategy at RBC Capital Markets.
“How the deal dies will matter for markets. An unambiguously bullish outcome would be if the group simply opts to stick with the original tapering timeline and signal its intent to keep 5.8 mb/d off the market until April 2022,” she wrote in a note on Friday.
However, RBC Capital Markets says that the prospects of $100-per-barrel oil is so “politically unpalatable” that U.S. administration officials will “appeal to the principal stakeholders in an attempt to prevent a virtual fireworks display on Monday.”
On the flip side, a price war could be imminent as well, if the talks go haywire.
“If the talks end in utter discord, there is a risk of a return to an every-man-for-himself production scenario that could cause a reversal of this year’s oil price rally,” Croft wrote. “We do not see this as the likely outcome, but cannot dismiss it entirely either. Certainly, it is not a black swan scenario.”
“So, in the very near term, a lack of agreement, obviously would mean that all production is loose, and that everybody starts close to a price war,” Alejandro Barbajosa, vice president of crude Middle East and Asia Pacific at Argus Media, told CNBC on Monday.
He added, however, that he does not think “OPEC is gonna go anywhere near that.”
