Why Opec+ made a surprise output cut and what's next for oil

In the case of an economic slowdown the 23-member alliance may be pleased to have acted pre-emptively to avoid inventories building up too much

OPEC's headquarters in Vienna, Austria. Major oil-producing countries led by Saudi Arabia and Russia are throttling back supplies of crude. AP
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Prince Abdulaziz bin Salman, the Saudi energy minister, has spoken of his intent to have speculators “ouching like hell”. The latest move of the Opec+ group of oil exporters should have achieved that.

When all analysts expected no change, Sunday surprised with a big cut in production targets, announced ahead of Monday’s official meeting.

The Opec+ members are making a “voluntary” cut, that is over their current commitments, of over 1.1 million barrels per day, running from May until at least year-end. Russia had already announced it would extend its unilateral 500,000 barrels per day reduction from June until the end of the year.

The drop will amount to a bit less than this in reality, as some members are already struggling to hit their targets, probably about 300,000 bpd from Russia and 700,000 bpd from the rest of the group.

Unlike previous cuts, this one has been parcelled out among the stronger members: Saudi Arabia will cut 500,000 bpd, the UAE 144,000 bpd, Iraq 211,000 bpd, Kuwait 128,000 bpd, and Oman 40,000 bpd. Nigeria, Algeria, Angola and others have effectively been contributing additional cuts for months already.

The key question is: why now?

Oil prices dropped to the low $70s per barrel during March in the face of worries over the banking sector, but they had begun climbing again over the past week.

The immediate crisis seemed to have been contained, inflation indicators have eased, end-user demand for oil products is strong, and China continues its post-Covid rebound.

The shutdown of Iraq’s export pipeline through Turkey following an arbitration ruling has removed about 450,000 bpd from the market, more than Baghdad has committed to cut. That situation might be resolved by negotiations with the authorities of the Kurdistan region followed by assurances to Ankara. Then again, these deals have proved fragile.

Some commentators have suggested a price “floor” around $80 per barrel, but these floors are elastic, more like trampolines, stretching upwards when higher prices seem sustainable.

The US administration had indicated that it would start refilling its strategic petroleum reserve when prices dropped to around $70 per barrel, but it failed to act on this in March. There are some suggestions this annoyed Opec, but this seems too minor an issue to trigger Sunday’s action.

After its fury over the 2 million bpd cut in October, the White House has taken the current news rather calmly, saying just that the new move was “inadvisable”.

Unlike in October, the American electoral clock is not near countdown, and the voting public has the spectacle of Donald Trump’s criminal indictment to watch.

These production cuts are not a political move by Saudi Arabia, but they are another sign — after normalising relations with Iran after Chinese mediation, and joining the Shanghai Co-operation Organisation — that Riyadh intends to follow its own interests.

In making such a cut, Opec+ has to have its eyes on two factors: competition, and demand.

On the competition side, with Russia under sanctions and within the tent, the US’s shale surge apparently at an end, and international companies only cautiously increasing budgets, there is no other large supply increment on the horizon.

As for demand, even though Brent crude jumped to $85 per barrel when trading opened on Monday, this is not particularly high in historic terms.

The inflation-adjusted average this century is $74 per barrel; allow for the last year’s inflation and that would be close to current levels.

Prices were already widely expected to cross $100 per barrel later this year, and that prospect now looks even more likely. That would add some inflationary pressure and possibly require further interest rate rises.

But in the case of an economic slowdown, Opec+ may be pleased to have acted pre-emptively to avoid inventories building up too much.

It’s possible that some of the major exporters are seeing weaker demand from their physical customers over the next two months.

Nevertheless, Saudi Arabia and others raised official selling prices for the second consecutive month in early March, with a further rise expected this month.

Several large new refineries in China, Kuwait, Iraq and later in the year in Oman and Nigeria, are in the process of starting up and will need crude, drawing in imports or reducing national exports.

Opec itself still foresees that this will be a strong year for demand. It actually raised its forecast for Chinese consumption in last month’s report, though keeping the global rise the same, at 2.32 million bpd.

The International Energy Agency also warned of “the potential for a substantial supply deficit to emerge”.

If this does happen, prices will rise substantially in the second half of the year.

Then Opec+ should be prepared to act just as decisively, and raise output to avoid a major price spike, which may be the difference between avoiding and enduring a global recession.

With its capacity building steadily, the UAE in particular deserves to see production targets heading up rather than down.

Robin Mills is chief executive of Qamar Energy and author of 'The Myth of the Oil Crisis'

Updated: April 04, 2023, 4:39 AM