Over the weekend, key OPEC+ members announced voluntary production cuts ahead of the formal JMMC later today. The move sent oil prices skyrocketing, enough for some analysts to predict it heading back to triple digits. That might be a bit optimistic of the crude bulls and warrants a closer look at the underlying motivations that caused a surprise move like this.
Oil prices were already on the move higher, as we pointed out recently, suggesting that the move isn’t in response to immediate market forces. Oil is politically fraught, and given the size of the announced cuts and who are the leaders of the move, there is rampant speculation that the move had more to do with geopolitics.
Price pressures are important
Oil producing nations spent a lot of money during the covid crisis while oil prices were low, leading to tighter financial situations. This created a general predisposition to keep crude prices higher since the end of the pandemic. The response to the war in Ukraine created important supply readjustments that caused the price of crude to skyrocket. Oil producing nations were able to recover some of the covid related costs. But the concurrent rise in inflation has meant erosion of the gains from higher crude prices.
Since before the pandemic, there has been about 16.4% in cumulative inflation. In 2019, oil prices fluctuated from around $60 to $70 per barrel. An average price of $65/bbl in 2019, when taking inflation into account, would be a little over $75/bbl in today’s dollars. With crude prices falling below the $70/bbl mark, that implies oil prices were lower than the pre-pandemic level in real terms.
Politics gets involved
The US had been selling millions of barrels of crude a month from its Strategic Petroleum Reserves (SPR) as part of an effort to bring down crude prices. After a milder than expected winter, and worries of a pending recession, oil prices had been under pressure recently. The White House had committed to replenishing the SPR if WTI prices fell below $70/bbl. Part of the reasoning was to support continued investment in the space, as many analysts have warned that the prospect of diminishing returns has kept investors out of the oil space. Consequently, oil supply was expected to face increasing challenges meeting what is forecast as increasing demand over the coming years.
However, after WTI dipped below $70/bbl, the US government said it wouldn’t move quickly to replace the SPR, suggesting buying wouldn’t start until the end of the year. Reports have circulated suggesting this has annoyed Saudi officials, and was the impetus for the move to cut production. Reportedly, the White House is not happy with Riyadh, given coordination with Russia and China, including settling sales of oil to the latter using yuan.
The tipping point
Russia had recently announced its own 500K bbl/day production cut, and announced that the cut would remain in place until the end of the year. That is not part of the OPEC announcement. There had been multiple press reports suggesting that OPEC would keep its current production at the next OPEC+ meeting. Which is why these cuts are seen as a major surprise.
Saudi Arabia was the leader of these voluntary cuts, meaning that they weren’t subject to an agreement to OPEC quotas. Countries making the cuts still have OPEC quotas that they can return to at their discretion. Saudi Arabia announced a 500K bbl/day cut. Iraq announced a 221K bbl/day cut, but currently has reduced exports by 450K bbl/day with the temporary suspension of Kurdistan exports through Turkey. Other countries joining include UAE and Kuwait for a total reduction of 1.15M bbl/day.
OPEC+ JMMT is expected to meet later today and confirm the measure. Technically, OPEC could maintain its current production quotas as expected, with the countries simply voluntarily not meeting their quota. Crude prices could be supported, but unlike a formal OPEC agreement, these voluntary cuts can be reversed at any moment. As an apparent geopolitical move, a reversal of the cuts would depend on political decisions that are hard to forecast by the market, leading to increased uncertainty.
