Surprise output cut by Opec+ a pre-emptive step to avoid having a huge build-up of crude stocks
Saudi Energy Minister Prince Abdulaziz bin Salman has spoken of his intent to have speculators “ouching like hell”. The latest move by 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 before Monday’s official meeting.
Opec+ members are making a “voluntary” cut that is more than their current commitments of more than 1.1 million barrels per day, running from May until, at least, the end of the year. Russia had already announced it would extend its unilateral 500,000 bpd 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 a barrel last month in the face of worries over the banking sector, but they had begun to climb again over the past week. The immediate crisis seemed to have been contained, with inflation indicators having eased while end-user demand for oil products is strong and as China continues its post-Covid rebound.
The shutdown of Iraq’s export pipeline through Turkey, following an arbitration ruling, removed about 450,000 bpd from the market, more than Baghdad has committed
to cut. The Iraqi government struck an agreement with authorities in the Kurdistan region on Tuesday to restart oil exports but such deals have proved fragile.
Some commentators have suggested a price “floor” of about $80 a 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 about $70 a barrel, but it failed to act on this in March. There are some suggestions that this annoyed Opec, but this seems too minor an issue to trigger Sunday’s action.
After its fury over the two million bpd cut in October, the White House has taken the current news rather calmly,
simply saying 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 former president 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 following 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, America’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 a barrel when trading opened on Monday, this is not particularly high in historic terms. The inflation-adjusted average this century is $74 a barrel; allow for last year’s inflation and that would be close to current levels.
Prices were already widely expected to cross $100 a 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 stocks from building up too much. It is possible that some of the major exporters expect to register 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 expects that this will be a strong year for
demand. It actually raised its forecast for Chinese consumption in last month’s report, although 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 increase, which may be the difference between avoiding and enduring a global recession.
With its capacity building steadily, the UAE in particular deserves to have its production targets heading up rather than down.
Prices were widely expected to cross $100 a barrel later this year, and that prospect now looks even more likely