An Opec member’s announcement of an unexpected production cut might have caused panic in the financial markets and capitals of the west. An oil producer cartel embargo in 1970s triggered an inflationary shock which plunged the world economy into deep recession. Opec+, a broader cartel that now includes Russia and has cut production by 1.6million barrels per day until the end, did cause an 8 percent increase in Brent crude’s price. However, some disapproval was expressed by the Biden administration. But the market response was muted. Opec+ has lost some power to shock, even in the midst of inflationary crisis.
The reason the reaction was muted is because the cuts were made against new data that suggests that the global economy might not be as strong as people thought at the beginning of the year. The International Energy Agency had predicted that oil demand would rise as the Chinese economy recovers and American and European economies recover. This would result in higher oil prices. Recent surveys have raised concerns about a possible recession, suggesting that oil demand may not be as high as predicted. In fact, Brent crude oil prices fell from $83 per barrel in March to $71.60 two weeks later.
Opec+’s move is therefore defensive. It is not a simple exercise in market power, but rather a panicky attempt at keeping prices stable and preserving their oil revenues through reducing the supply to meet expected demand. It is also notable that this decision was made so quickly after Prince Abdulaziz bin Salman (the Saudi energy minister and the prime mover in cartel) had assured the markets in February that no production cuts would be made beyond the ones Opec+ had agreed to last October. This decision also came just weeks after Opec+ members agreed that March’s fall in oil prices was financial driven. Oil prices rose from $76 in March to $76 last week.
Even this defensive move comes with risks. Opec+’s goal is to maximize oil revenues. This presents a difficult balance. It will only increase inflationary pressures in western countries, causing further rate increases that could devastate the economy and decrease demand. Higher oil prices could also lead to a deeper economic recession, which would reduce oil demand. The market is currently more worried that higher oil prices will result in lower growth than higher inflation. This can be seen in the fact that oil prices will stay below $100 per barrel after Sunday’s cuts.
The consequences of Opec’s decision will not be limited to financial. Russia will undoubtedly be one of the biggest beneficiaries from its actions, as it will see an increase in oil revenues. The tensions between Washington and Riyadh are further illustrated by Saudi Arabia’s decision not to cut production. This despite American pleas that it do so to reduce dependence on Russian oil. These tensions have grown since 2014-16 when Opec launched an Opec price war to destroy the US shale gas sector. They were further accentuated last month by the China-mediated peace agreement between Saudi Arabian and Iran.
Riyadh’s refusal to listen to the pleas of its former ally is more a sign of Opec’s diminishing power than America’s decline in the Middle East. Saudi Arabia’s policy is driven not by a desire for geopolitical influence (as it did in 1973 with the Yom Kippur War oil embargo), but by a determination to pursue its national over-riding interest, which is to diversify its economy from oil. To balance its domestic budget, which must meet the needs of its growing middle class and young population, it requires an oil price of approximately $85 per barrel. To fund the massive new construction projects promoted by Mohammed Bin Salman (the de facto ruler), it needs reliable oil revenues. Vision 2030 is a collection of these projects. It includes a Red Sea resort that is as big as Belgium and a high-tech desert city that’s 33 times larger than New York City.
Riyadh and other petro-states must be prepared for a possible further decline in their power as the world shifts to cleaner energy. The more Opec raises oil prices, then the greater incentive the rest of the globe to invest in renewable energy. Half of the world’s oil consumption goes to road transport. This makes it vulnerable to the growing global shift towards electric vehicles. It’s striking to see that, despite oil prices rising at the beginning of this week, the lithium price, which is the key ingredient in electric vehicle battery batteries, recorded its 16th consecutive day of trading losses. This has significantly reduced the cost of making electric vehicles, with it now falling by nearly 60%.
This suggests that Opec+ must balance in both the short and long-term, which will limit its ability to use its market power. The geopolitical as well as macroeconomic perspectives were severely hampered by this week’s production reductions. Saudi Arabia and the other cartel members know that pushing prices too high will not only cause a global economic crisis and a slump in global demand but also risk damaging their market. This should be enough to make sure Opec doesn’t push the price higher than $100 per barrel. This is not 1970s.