Why Opec+ is reducing oil production now

Opec+ has stunned oil markets by announcing an unexpected production cut of over 1mn barrels per day. This raised the price of oil and increased tensions with western allies.

What does this mean for the wider market?

Opec+, which includes its largest members Saudi Arabia, Russia and Russia, wants to support the oil prices or push them higher.

Brent crude oil, an international benchmark, fell to $70 per barrel last month as the turmoil in banking led to the selling of risky assets. For much of the last year, it was closer to $100 per barrel.

The price of oil had risen to $80 per barrel by last week’s end — which is not far from where it was traded in 2023. This price is not low by historical standards. Analysts see the surprise cutting not as a defensive move of the cartel but as an assertive move made by the largest members, such as Saudi Arabia.Saudi Arabia is also disappointed by US comments last week that it would take “years” to replenish its Strategic Petroleum Reserve. This Reserve was partially drained in 2022 in order to keep prices under control after Russia’s invasion of Ukraine.

The US indicated that it was determined to keep prices from rising too much and would continue to pressure allies like Saudi Arabia to maintain production, but it would also use SPR to help put some level of control on the market.

This was supposed to reassure Opec+ members who might now feel letdown and are responding with cutting supplies.

Opec+ doesn’t have to worry about losing market share to its rivals. The US shale production is not growing as fast as it was last decade. Therefore, Opec+ is less concerned with rivals filling the gap quickly.

Brent crude oil rose as high as 8 percent, from close to $79 per barrel on Friday, to more than $86 per barrel by Friday. Then, it began to temper slightly.

Oil traders were already optimistic about the prospects for the second quarter of the year. This was due to a stronger global economy and China’s lifting from Covid-19 restraints, which means that demand will outstrip supply.

Banks who forecast higher prices are now double down. Goldman Sachs increased its end-of-the year forecast from $90 per barrel to $95 per barrel.

Opec+ may hope for higher prices still. Many hedge funds sold oil last month during the banking crisis, when risky assets like commodities were caught in a wider market sell-off.

Funds may be able to re-enter market after Opec+ has shown its willingness to act.

Analysts at Rystad said that the announced cut would tighten an already tight oil market. This would drive Brent’s benchmark to $100 per barrel earlier than expected. It would also push the price up to $110 per bar this summer,” Rystad analysts added on Monday. They believed the cut would increase “support of about $10 per barrel.”

It’s possible. There are signs that oil demand is slightly lower than expected, especially in developed countries, during the first months of 2011.

The cuts were deemed a precautionary measure that aims to stabilize the oil market.

According to Citigroup analysts, Ed Morse stated that the cuts were made in order to “strengthen a market that was becoming increasingly weaker with faster stock builds through 2023’s first quarter”.

However, fears of a deep recession are now lessened partly due to sharply falling energy prices (primarily European natural gas).

According to the International Energy Agency, there was an implied deficit between 1mn & 1.5mn barrels per day in the second half this year prior to Opec+’s new cuts.

Helima Croft, RBC Capital Markets, said that the move showed Riyadh’s commitment to a “Saudi-first” policy as the kingdom becomes more assertive. It is also willing to show the US it has other allies.

Relationship between the Biden administration, Crown Prince Mohammed bin Salman and the Biden administration is still in turmoil. The US has described the cuts as “not recommended at this time”.

Croft stated, “It is evident that Saudi Arabia has been prepared to endure increased friction within the bilateral relationship.”

“The bottom line, Washington and Riyadh simply do not have the same price targets for their key policies initiatives,” Croft said. He also stated that Riyadh is gaining in importance because of its “bilateral relation with China.”

China is however not supportive of oil prices going too high. Citi believes that Beijing may slow down oil purchases to replenish its strategic reserves.

Saudi Arabia’s determination not to stop working with Russia, which was instrumental in the creation of the expanded Opec+ group back in 2016, will likely continue to be a source for tension with the US. Many see Russia’s production cuts as an answer to western sanctions.

Inflation will be of primary concern. The main concern will be the impact on inflation. A higher oil price could make it harder for central banks to control inflation. They may have to raise interest rates further, or keep them higher, in order to do so.

Investors are still divided over whether March’s Federal Reserve rate hike was the final, but they increased their odds of a quarter-point increase on Monday.

The market’s prediction peak in eurozone interest rate has also been slightly higher.

It remains to be seen how much oil prices rise. The impact of the cuts on prices could be limited if they do not push them to $100 per barrel or higher.

According to Bjarne Schieldrop, a Swedish bank SEB, “Oil prices were about $100 per barrel last year” and $100 per barrel in 2023 should not do any damage other than potentially adding some headwinds for the global economy.”

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