What analysts are saying about the surprise output cut of Opec+

Brent and WTI, the world’s two leading crude oil futures contracts, rallied on Monday after members of the group pledged production cutbacks

Analysts offer their perspective on oil prices the day after Opec+ announced cuts to output. Reuters

Members of the 23-member Opec+ alliance of oil producers made a surprise announcement of cuts on Sunday as a precautionary move to stabilise crude prices.

Saudi Arabia, the UAE, Iraq, Kuwait, Algeria, Oman, Kazakhstan and Gabon will together cut output by more than 1 million barrels of crude a day from May until the end of this year.

Russia said the 500,000 bpd cut it was making from March to June would continue until the end of the year. This takes the output cut to over 1.66 million bpd by the end of this year in addition to the 2 million bpd production cut implemented at the end of last year.

This led to oil prices surging at the start of trading on Monday with both Brent, the benchmark for two thirds of the world’s oil, and West Texas Intermediate, the gauge that tracks US crude, rising more than 6 per cent.

Brent was trading 5.7 per cent higher at $84.44 a barrel at 12.46pm UAE time, while WTI was up 5.78 per cent at $80.04 a barrel.

Opec+ cut its collective output by two million barrels a day last year and was largely expected to stick to the agreed production levels at its meeting on Monday.

However, oil prices had plummeted to a more than one-year low last month because of a banking crisis in the US that had spread to Switzerland, which triggered a broad sell-off in financial markets and raised fears about the increased probability of a recession.

Here is what analysts are saying about Opec+'s decision — and its implications.

Goldman Sachs

The US investment bank recently reduced its oil price forecasts for 2023, citing growing crude supplies and lower demand. The investment bank now expects Brent to trade at $95 a barrel by the end of this year from a previous $90 estimate and $100 in 2024 compared with a $97 forecast.

“Opec+ has very significant pricing power relative to the past given its elevated market share, inelastic non-Opec supply, and inelastic demand,” analysts wrote in a research note.

The group's surprise cut is “consistent with the new Opec+ doctrine to act pre-emptively because they can without significant losses in market share”, they said.

“Once again, Opec+ implements a precautionary production cut like in October 2022. However, unlike then, the momentum for global oil demand is up not down with a strong China recovery, the Brent forward curve is backwardated, and refining margins remain resilient.”

MUFG Bank

“Unlike the previous iterations of quota reductions, most of the headline number is likely to translate into an actual drop in physical supply,” said Ehsan Khoman, head of emerging markets research for Europe, the Middle East and Africa at Japan's largest bank.

“This time, the production cut responsibilities are primarily shared among member countries which are at least close to meeting their target levels, if not for Russia — incidentally, the five largest Opec+ producers bear the brunt of the total,” he said.

The cuts will “further tighten fundamentals [and] … help remedy the large exodus of oil investors that has left prices underperforming both fundamentals and other cyclical asset classes”, Mr Khoman said.

“While exceptional, this cut is also logical as it maximises the group’s revenue today with minimal sacrifice of future profitability. It reinforces backwardation and further increases the carry in oil.”

MUFG Bank forecasts Brent crude will average $88 a barrel in 2023.

“The ability for Opec to conduct such a large cut is entrenched in the lack of any supply elasticity, with US shale activity showing signs of slowing, negligible spare capacity outside of core-Opec+ producers and with Russia’s production set to decline,” Mr Khoman said.

“This is ultimately a return to the approach by Opec+ wherein it behaves under the rational behaviour of a dominant producer with pricing power.”

Rystad Energy

If the announced cuts are fully implemented they would further tighten an “already fundamentally tight oil market”, said Jorge Leon, senior vice president at Rystad Energy.

The cuts will drive Brent towards $100 a barrel sooner than expected and would push the price to about $110 a barrel this summer, he said.

“The fact that all these countries are adhering to the current Opec+ quotas, with compliance levels at close to 100 per cent, implies that the announced voluntary cuts will also most likely be real,” Mr Leon said.

“From a supply side perspective, the cuts signal the group is willing to defend a price floor well above $80 per barrel and prioritise revenue versus market share. From a demand-side perspective, these cuts may be signalling that Opec+ believes that there are enough recessionary indicators in the market.”

Recessionary indicators have been strengthened by the strain on the banking industry which is weighing on the broader the financial sector, he said.

Emirates NBD

The announced cuts from several Opec+ members will widen the oil market deficit in the second half of 2023, provided they are held for the full tenure of the agreement, said Edward Bell, a senior economist at Dubai's largest lender, Emirates NBD.

“Our prior oil market balance assumptions had a deficit emerging in the second half of this year as demand was set to recover strongly from the second quarter onward as China’s oil demand normalised,” Mr Bell said.

“With the new cuts from Opec+ taken into the baseline, the deficit will near on three million barrels a day by the fourth quarter of this year and drain inventories down to 53 days of OECD demand. The pre-pandemic average for inventory days of demand had been about 62 days so the cuts will have a meaningful tightening effect on balances.”

The cuts from Opec+ help oil prices recover from recent lows, particularly in the second half of this year, he said.

“For now, we hold our recently revised oil forecasts unchanged — targeting Brent at an average of $92.50 a barrel in the second half of the year — though the cuts do provide some upside risks to that view.”

“A tighter oil market in the second half of the year will also mean wider backwardations to develop in the structure of the futures market.”

Abu Dhabi Commercial Bank

Abu Dhabi Commercial Bank economists said oil prices were already strengthening ahead of the announcement as concerns over the global banking sector eased.

"We see the Opec+ move as potentially reflecting the group’s concern over an uneven and patchy recovery in China and weaker global growth," said Monica Malik and Sri Virinchi Kadiyala.

"However, the latest production cut could significantly tighten the oil balance in the second quarter of 2023 and especially in the second half of 2023 when Chinese oil demand is expected to ramp up, skewing price risks to the upside."

ADCB now forecasts for Brent, which is now expected to average $89.6 a barrel in 2023 and $91.5 a barrel in 2024.

"The solid oil income outlook supports the ability of GCC governments to move ahead with their transformation plans," ADCB economists said.

"We believe that Opec+ will likely look to keep oil prices above the $80 a barrel level in the medium term while remaining flexible on its oil output policy."

S&P Global Commodity Insights

Even before the pledges of Opec+ producers, the provider of energy and commodities information anticipated oil prices were to increase.

This “in large part to a rise in jet fuel demand within China and higher gasoline demand in the western portion of the world … rising demand in the second half of 2023 will tighten the supply-demand balances”, according to Ha Nguyen, executive director for global oil at S&P Global Commodity Insights.

Swissquote Bank

Ipek Ozkardeskaya, senior analyst, said the output cuts could push oil prices to $90 to $100 a barrel “but it will be hard”.

“The oil bulls’ determination will depend on how much the Opec+ is willing to push prices higher by cutting output. How much Opec+ is willing to push prices higher will depend on whether the world economy could absorb higher energy prices,” Ms Ozkardeskaya said.

She cited Caixin PMI data released in China on Monday that shows manufacturing in the world's biggest importer of oil unexpectedly fell in March, to the 50 level, the neutral mark that divides expansion and contraction.

“If China can’t boost global growth expectations, it will be hard to imagine a strong rally in oil prices to $90 to $100 range,” Ms Ozkardeskaya said.

At this point, the 200-day moving day average will “likely act as a solid resistance to the post-Opec rally and oil prices could stabilise within the $75 to $80 range” she said.