Oil prices rose sharply on Monday following surprise production cuts by the Organization of the Petroleum Exporting Countries (OPEC) and its allies, known as OPEC+.
Both oil benchmarks, including Brent crude and West Texas Intermediate (WTI) jumped 6% on the day after the organization unexpectedly announced voluntary production cuts of 1.66 million barrels per day (bpd) from May until the end of 2023.
The move raised concerns among economists who warned that elevated oil prices could make it more difficult to cut down the cost of living. However, some argue that petrol prices shouldn’t increase significantly unless the higher oil price is sustained over a couple of days.
Conference Board of Canada chief economist Pedro Antunes said,
“Let’s not forget that everything we transport, including food, will be affected by higher oil prices. Oil feeds into plastics and a lot of other consumer products. It just adds another sort of layer of cost pressure to pretty much everything we consume,”
Inflation Worries
The abrupt decision by OPEC+ brings the total volume of cuts to 3.66 million bpd including a 2 million bpd reduction in October 2022, representing roughly 3.7% of global demand.
Callum Macpherson, head of commodities at Investec, said the motivation behind the production cut remains unclear given the “very limited public statements that have been made.”
He argued the decision may be due to worries “about the spillover of equity recent market volatility into oil prices or because members perceive a weakness in the physical market that is not apparent to the wider market.”
UBS analysts speculated that supply cuts may have been aimed at short-sellers. UBS analyst Giovanni Staunovo said,
"Voluntary production cuts are nothing new, but the scale of this round is unprecedented. We continue to see Saudi Arabia and the other OPEC+ members keeping their hands on the oil wheel and remaining in control of the market."
The cuts also raised concerns among investors, who fear that another inflationary shock to the global economy from higher oil prices could force central banks to deliver more interest rate hikes.
Market participants have been attempting to predict how much longer the U.S. Federal Reserve may have to keep increasing interest rates to bring down inflation and how that would impact the likelihood of the U.S. economy falling into recession.
U.S. manufacturing activity plummeted to a three-year low and could be headed for another downturn due to tight credit and elevated borrowing costs. U.S. officials have been urging leading exporters to raise oil output in a bid to bring down energy prices, which have been one of the key drivers of inflation.
A spokesperson for the US National Security Council, said,
"We don't think cuts are advisable at this moment given market uncertainty - and we've made that clear,”
KPMG head economist Yael Selfin said the oil price jump could complicate the battle against inflation. However, she said that soaring prices won’t necessarily result in higher household energy bills.
"The energy price cap, that households benefit from, has already been determined using earlier market expectations. Plus, when you look at energy use in households, it tends to be more gas-heavy rather than oil."
Gasoline prices in the US have so far averaged around $3.22 a gallon in 2023, compared to 2022’s average of $3.29 per gallon.
How Far Can Oil Prices Go?
Russia also announced it would extend its half-a-billion bpd production cut until the end of 2023, minutes after OPEC+ members, including Saudi Arabia, Kuwait, Oman, Iraq, and the UAE, said they were slashing output until the end of the year. Russia is also a member of OPEC+ - which includes 13 OPEC members and 11 non-OPEC members.
This is the second time Russia has extended production curbs since the country first announced them in February. Deputy Prime Minister Alexander Novak said on Feb. 10 that Russia would trim oil output by 500,000 bpd in March, though he later announced the cut would continue until the end of June. A few weeks earlier, he said Russia was nearing its targeted level of output of 9.5 billion bpd.
Higher prices would likely provide a financial boost to Moscow in its war against Ukraine, which could further disrupt relations between Saudi Arabia and the U.S.
Some analysts and industry executives believe that cuts by OPEC+ could spur demand for U.S. oil in Europe and Asia and encourage some other exporters to raise output. BTU Analytics senior manager for energy consultants Matt Hagerty thinks that output reductions by Middle East oil producers would leave markets short by an average of 2.3 million bpd in H2 2023.
Jorge León, a market researcher at Rystad Energy, said U.S. producers could inject an additional 200,000 bpd by the end of 2023, adding that new production would likely be exported to Europe.
According to government data, U.S. exporters produced around 12.5 million bpd in January, with production in the country’s biggest shale basin expected to increase by 400,000 bpd per day this year, as per estimates by tech firm Enverus. This figure represents around half the pre-pandemic level seen in 2019.
In the wake of the cuts, the majority of Wall Street analysts hike their Brent crude forecasts to around $100 per barrel by the end of 2023. Brent crude oil is a popular commodity in the world of futures trading, where current forecasts influence futures contracts where traders can lock in on certain prices. Goldman Sachs analysts raised the outlook for Brent prices to $95 a barrel by the end of this year, and to $100 for 2024.
Fereidun Fesharaki, founder and chairman of consultancy FGE, echoed these predictions, saying that prices “can easily rise above $100 a barrel.”
"Our forward balances show a very steep draw in inventories through the end 2023," he added.
Rystad Energy believes that Brent could surge as high as $110 per barrel this summer, citing tightness in the oil market following OPEC+ curbs.
Summary
Oil prices are moving higher this week after OPEC+ announced surprising output cuts in a bid to avert a further slide. Oil had been moving lower in recent months on recession fears. However, the most recent OPEC+ decision is likely to support the prices, at least in the near term.
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Shane Neagle is the EIC of The Tokenist. Check out The Tokenist’s free newsletter, Five Minute Finance, for weekly analysis of the biggest trends in finance and technology.