When thinking about oil, Saudi Arabia and OPEC+, the fabled $100-a-barrel target isn’t relevant any more. In truth, it hasn’t been since June, when the cartel’s announcement of a plan to boost production effectively signaled it was abandoning its quest for triple-digit prices. Now, the reference value that matters is $50 a barrel.
First, a spoiler alert. I’m not about to predict whether that new lower level will materialize, other than warning that it’s far more possible than the market seems to think1. Instead, a general observation: All things being equal2, the oil market looks oversupplied in 2025, and that means lower rather than higher prices — so given a binary choice between $100 and $50 for next year, I’d take the latter bet despite all the Middle East geopolitical risk.
While OPEC+ is typically portrayed as monolithic group, it’s plagued with factionalism. Therefore, the cartel doesn’t have just a single reaction function, but instead two layers. One represents how it responds as a group to external events — the growth of the US shale industry, say — with the second depending on how each OPEC+ member reacts to the actions of its fellow affiliates.
The second layer is unimportant when the cartel as acting in unison with little, if any, dissidence. But there are times — and I believe now is one of those — when internal politics matter more, which can dramatically alter OPEC+’s reaction function.
For the last three years, OPEC+ has focused on keeping oil prices as close to $100 as it could by keeping global inventories tight. I called it the “Saudi First” strategy. Whether one calls it an unofficial target, a goal, a hope, an aim or an aspiration doesn’t matter. By its actions, including cutting output when prices were close to $90 a barrel, the bloc showed its hand: It wanted triple-digit values, making other considerations secondary.
Now, that’s changed, due to a combination of factors. First, OPEC+ has tacitly recognized that its $100 policy was boosting annual non-OPEC+ supply growth above trend demand. Sticking to its high prices strategy meant accepting an ever-declining market share. Second, the cartel accepts that elevated crude levels hurt demand growth, and sustaining consumption is important in the face of the energy transition. Third, the global economic cycle has turned, and oil, just like every other commodity, is sensitive; lower prices are the natural consequence of weaker growth. Fourth, several OPEC+ members have invested billions of dollars in new production capacity and have pushed to pump more, challenging the strategy. To avoid a schism, the group has had to change its overall reaction function.
That’s the main explanation for why OPEC+ in June agreed to a complex plan to hike production from September until late 2025 that would eventually boost output by more than 2 million barrels a day. Granted, OPEC+ said the increases would be conditional on the health of the market, making the deal a statement of intent. With prices falling, the build up has already been delayed by two months, until December.
What comes next? I don’t think Saudi Arabia has made up its mind, and what occurs in 2025 will be decided by what other OPEC+ members do in October and November. The most crucial factor is whether the cheaters stop cheating. That will inform what Riyadh does. So will events in the Middle East. I remain convinced, as I have been for the past year, that neither Israel nor Iran want to involve oil in their attacks. Likewise, the world’s two largest oil consumers — the U.S. and China — surely will have told both sides that oil is off limits. But I must admit that the risk of miscalculation grows by the day.
At the same time, everyone at OPEC+ is waiting to see who will occupy the White House next year. The current plan to increase output in monthly increments is problematic, nonetheless. Simply put, I don’t see demand for those extra barrels in 2025 — unless the cartel is prepared to accept a very visible increase in inventories and thus much lower prices. Here are the options I see:
1) OPEC+ cheaters stop their over-production and Saudi Arabia and others in the cartel have a change of heart, fearing a price slump. Rather than increasing production, they cut output in early 2025. Wrongfooting most traders, the cartel sends oil prices back into the $80-$100 range. Never say never, but I would be shocked if that scenario materialized as I believe OPEC+’s reaction function has changed.
2) OPEC+ compliance improves dramatically, including via compensation cuts by the cheaters. The group delays the monthly production increases for six months, in turn avoiding a jump in inventories in early 2025. In that scenario, oil finds a floor around $70 and moves back toward $80. I don’t think Riyadh is contemplating delaying the output increases forever, but I see some scope for the kingdom agreeing to wait until the second half of next year. One reason is a bet that US shale growth is moderating; another is the hope that Beijing will successfully refloat its economy, boosting oil demand. This scenario gets a maybe from me.
3) The cartel sticks to its plan to boost output in monthly increases from December onward as compliance improves somewhat. The Saudis cut spending to weather a period of low prices — something already flagged in the preview of the country’s 2025 budget. In that scenario, the oil market would be oversupplied next year, particularly during the second quarter, when seasonally demand is lower. The resulting inventory build-up pushes oil prices toward $60 and perhaps — even if only briefly — even lower toward $50 during the second quarter of next year, before recovering later in the year as US shale production growth slows down due to low prices. To me, this is the most likely scenario.
4) OPEC+ compliance doesn’t improve at all. In response, the cartel not only goes ahead with the monthly output increase from December, but Saudi Arabia pushes the group into accelerating production of those extra barrels. As a result, the market is hugely oversupplied, and oil prices drop to $50 and even lower. The market doesn’t crash, however, because Riyadh stops shorts of launching a full price war. I sense that this outline, whispered by some OPEC+ officials and echoed by oil traders who say they’ve been told about it, is a not-so-quiet Saudi campaign of verbal threats so the cheaters improve compliance. As such, I don’t consider it as likely.
5) A full-scale price war. Compliance doesn’t improve at all and gets even worse. Saudi Arabia raises production to its maximum capacity of 12.5 million barrels a day, up from today’s output of 9 million. Every other OPEC+ country follow suit. The market faces a huge glut similar to what was witnessed in 2020 — and prices crash. If history is any guide, the $50-a-barrel level won’t act as a floor, and prices would likely plunge much, much lower. (Remember that during the last price war in 2020, zero wasn’t the floor either; minus $40 was.) As things stand, this final scenario looks extremely unlikely to unfold. But Saudi Arabia has fought two price wars in the past decade, so we should at the very least entertain the possibility of it occurring.
Whatever happens, oil prices look set to be nearer $50 a barrel than $100 for the foreseeable future. Only an all-out war in the Middle East can change that outlook.
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