Memorial Day Weekend Geopolitical Strains Drive Oil Prices Up as OPEC+ Reviews Capacities

Crude prices rose by over $1/bbl this morning following continued news of geopolitical tensions in the Middle East after the Memorial Day weekend. Reported clashes between Israeli troops and an Egyptian border guard resulted in the guard’s death, and Israel conducted airstrikes on a camp for displaced Palestinians on Sunday.

Concerns about U.S. interest rates staying high for an extended period led to a weekly loss for crude oil last week, as higher rates increase borrowing costs, potentially slowing economic activity and reducing oil demand.

OPEC+ is working towards finalizing the oil production capacity for its member countries by the end of 2024. This task has historically caused tensions due to the calculation method for each nation’s output target. Members of OPEC+ usually push for higher capacity to secure higher output targets after the group’s percentage cut is applied. OPEC+ has been reducing output to support oil prices, but many members, reliant on oil export revenues, have an incentive to aim for the highest production quotas possible.

Previously, OPEC+ members reported their own capacity figures, which led to disagreements. To address this, the group has hired three independent consultancies to assess member capacities by the end of June. These assessments, however, will not be ready for the next OPEC+ online meeting on June 2. Despite this, the group must progress on this issue to use new capacity figures for estimating future cuts when the existing ones expire at the end of 2024.

Saudi Arabia, OPEC’s de facto leader, and the world’s third-largest producer, advocates for rewarding countries that have invested in expanding capacity. The UAE, having significantly increased its capacity, seeks to use some of it to gain a return on its investment. Countries like Nigeria struggle to meet existing targets due to inadequate investment and maintenance. Even if they can’t meet their targets, countries are reluctant to see their notional capacity cut by OPEC+, as it would mean lower production quotas. For instance, Angola left OPEC in December 2023 after being assigned a lower capacity than it believed it deserved.

Production capacity sets the reference point for production targets and subsequent cuts. Although OPEC+ regularly publishes cuts, it does not frequently release capacity numbers, adding to the complexity. Saudi Arabia, for example, has a declared capacity of 12 Mbpd but produces around 9 Mbpd under its current quota. Meanwhile, the UAE, with a reference production of about 3.5 Mbpd, claims to have nearly reached a capacity of 5 Mbpd and seeks an increased quota. Other countries like Iraq and Kazakhstan are also pushing for higher production capacities. Historically, distrust within OPEC regarding self-reported data has been an issue, complicating capacity discussions further. The International Monetary Fund notes the differing price needs among members, with Saudi Arabia requiring $96.20 /bbl to balance its budget, while the UAE needs only $56.70/bbl for 2024.