- The latest production cut could result in a $10 rally or more a barrel
- The counter-effect will be higher inflation and, possibly, more Fed hikes
- Ultimately, the focus on recession will return; this time, it won’t be just talk
Just over a week ago, I wrote that it will probably take another 10 days before the longs in oil can feel settled and in control of the market again.
That, I said, will be on or after the OPEC+ virtual meeting on April 3 that allows the world’s oil producers to reintroduce the fear of tight supply into the market’s narrative — to counter the liquidity fear spawned by last month’s banking crisis and any recession fear exacerbated by Fed Chair Jerome Powell’s outlook on inflation and future rates.
That day is now here, and the 13-member Saudi-led Organization of the Petroleum Exporting Countries and its 10 allies steered by Russia have done what I thought they would - reintroduce the fear of supply squeeze into the market. OPEC+ has done a little more and a little less than I imagined. Let me break down for you what that “more” or “less” means.
For starters, OPEC+ has certainly exceeded market expectations with the production cut. Running up to the group’s virtual meeting today, expectations had been for a stay of the 2 million barrels per day reduction from October that the market had grown comfortable with. That daily cut of 2 million barrels accounted for about 2% of global production. The additional cut now is for nearly 1.7 million barrels more per day, which amounts to a total world output of 3.7 million barrels daily or 3.7% in all. That’s the “more.”
The “less” involves the number of countries involved in the new round of cuts. Just seven of the 23 nations in the alliance — about a third of the group — will contribute to the new cuts, negotiated primarily between the Saudis and Russians to get ahead of a global slowdown.
According to the math, the United Arab Emirates would contribute 144,000 barrels daily to the cuts, Kuwait 128,000, Oman 40,000 bpd, and Algeria 48,000. Kazakhstan — already in the news over the past week over an exports blockade — is apparently cutting 78,000 barrels daily, notwithstanding the present outage.
Russia will extend till the end of the year the 500,000 barrels a day it announced a month ago. The biggest portion of the new cuts is an additional half a million barrels to be contributed by the Saudis. As the Wall Street Journal put it, the kingdom wants higher crude prices to fund its “ambitious domestic projects and replenish Russia’s reserves.”
The last bit sticks out to me as utter fertilizer. What Riyadh is doing really is helping shore up Russia’s economy as Western sanctions against Moscow for its invasion of Ukraine have squeezed the Kremlin’s oil revenue, particularly the G7’s price cap, which prevents most countries from paying more than $60 for a barrel of Russian crude.
Vladimir Putin’s audacious bet of crippling Europe during the most recent winter also failed spectacularly. Mother Nature delivered warmer-than-typical weather, further enhancing the bloc’s seamless transition from the Russian gas supply. Global gas prices are down about 70% since December, and crude hit 15-month lows just two weeks ago. To make matters worse, the Russian ruble is down about 20% versus the dollar over the past four months
The House of Saud feeling compelled to help out an embattled ally it has an economic pact with wouldn’t be an issue if not for the circumstances at hand. The Ukraine invasion has been condemned by most countries except those that have a clear advantage of working with Moscow, i.e. China, India, and, now, Saudi Arabia. Right at the outset of the invasion, the Saudis tried to paint OPEC as apolitical (despite oil being the world’s most political commodity).
The Saudi motive of defying the West, particularly the United States, which it has deeper ties with and a history of alliance with than Russia, has more to do than with oil. Crown Prince Mohammed bin Salman, who will officially be the kingdom’s next ruler, hasn’t forgiven — and probably never will — President Joe Biden for accusing him of the murder of Saudi-national-turned-U.S.-resident Jamal Khashoggi.
Even Biden's state visit to Riyadh hadn’t helped mend personal relations between the two men, with the crown prince being famous for remembering slights. Under MBS, as the crown prince is known by his initials, the Saudis have been increasingly veering away from America as a provider of Middle East security towards relatively new economic allies, Russia and China. It should be noted that Beijing, not the United States, brokered recent talks that patched back longtime rivals Saudi Arabia and Iran.
Anyway, by declaring OPEC as apolitical, the Saudis indirectly assisted Putin in weaponizing energy as he constantly used Russia’s gas supply to Europe as bait to advance his war on Ukraine. In August, Putin’s overtures helped send European gas prices to record highs of €320 ($350) per milliwatt hour. Earlier, the Saudis rejoiced, too, as crude prices reached the post-2008 zenith of almost $140 a barrel in March 2022 itself, days after the Ukraine invasion.
By the third quarter of 2022, things weren’t working out as well for OPEC as COVID issues in top oil buyer China, emergency reserve oil releases by the Biden administration, and recession fears in Europe and the United States combined to send oil to below $80 a barrel the first time since the Ukraine invasion. The 2-million-barrel per day cut announced in October did not help to alleviate the selloff that sent a barrel of U.S. West Texas Intermediate, or WTI, crude to under $65 by mid-March. Hence, the new cut was announced on Sunday.
The problem with this latest cut is that it will likely follow the pattern of the November cut in the sense that it will probably be enforced diligently for a month or two. After that, the onset of summer and typically higher demand from consuming countries will prompt the countries that are supposed to continue doing the cuts to lessen or even abandon them.
OPEC Manipulation Vs. Recession
For the record, since November, OPEC+ is supposed to be practicing a daily output cut of two million barrels. Yet, overproduction was routinely reported and happened as late as March on the Saudi side, with the defense being that the market is balanced. This brings us to OPEC price manipulation, a craft it has perfected since the pandemic.
Except for a brief and very public row between them at the height of the COVID-19 breakout in 2020, the Saudi-Russian joint stewardship of OPEC+ has been admirable in holding up the market — mostly with half-truths about production and veiled threats on output squeezes seldom carried out over the past half year.
Given that a third of global supply is already at risk from the sanctions imposed on Russia over Ukraine, the cartel knows that the fear of undersupply is greater to the oil market than concerns of a glut. Thus, the careful dropping of words like “the market needs to be balanced” is often enough to create a premium of between $5 to $10 per barrel anytime from a week before an OPEC meeting to one after it.
After crude prices hit 15-month lows in mid-March, Iraq's Prime Minister Mohammed Shia al-Sudani and OPEC Secretary General Haitham Al Ghais stressed the need to coordinate among oil-exporting nations to ensure prices do not fluctuate and impact both exporter and consumer countries. Interestingly, OPEC+ never sees the need to coordinate or “balance” the market when prices are rising.
John Kilduff, partner at New York energy hedge fund Again Capital, said,
“Data will show that OPEC+ has done bunk in many months with the so-called production cut of 2.0 million barrels. But the market keeps buying the BS.”
If one thinks it through, it’s really quite simple: No producer will turn away a buyer who wants more oil because the buyer will simply go to another source.
The last time OPEC+ practiced enduring discipline on cuts was during the height of the pandemic because there was no demand then anyway. Underinvestment in oilfields since has naturally reduced output. With demand back at 2019 levels, almost every producer has been maxing output while publicly proclaiming adherence to the production cut announced in October.
What OPEC is doing is using the power of the megaphone: Announce a cut, get the price impact, then produce what it really wants. The price impact from the latest announcement is already visible to us, with a rare 5% jump in Monday’s Asian trading that sent U.S. crude to above $81 and global benchmark Brent to over $85.
Technical charts at least indicated that WTI had overdone its rally ahead of Monday’s New York trade by breaching $80 with a “gap up” open. Sunil Kumar Dixit, the chief technical strategist at SKCharting.com, said:
“The first round of the bullish spike with a test of the horizontal technical resistance of $81.58 is done. We’re now in consolidation mode below that high.”
Even so, others expected higher targets to follow through.
The head of investment firm Pickering Energy Partners said in comments carried by Reuters that a $10 gain from Friday’s close of $75.67 for WTI was possible. Goldman Sachs, Wall Street’s biggest cheerleader for oil, raised its year-end call for Brent to $95 from a previous $90. It also put out a 2024 forecast of $100 versus an earlier projection of $97.
Goldman said in remarks that probably carried more candor than intended:
"Today's surprise cut is consistent with the new OPEC+ doctrine to act preemptively because they can without significant losses in market share,"
What will get crude prices down again is probably the re-emergence of recessionary signs — and this time, they may not just be a threat anymore. At least the oil rally expected in the near term is a potentially ominous sign for global inflation just days after a slowdown in U.S. price data boosted market optimism, said Reuters in an analysis.
Monday’s surge in energy costs somewhat overshadowed Friday's slower reading for core U.S. inflation, which had seen Wall Street end the month on a strong note. The jolt to inflation expectations saw yields on United States 2-Year Treasuries rise 4 basis points to 4.11%, while fund futures tracking the Federal Reserve pared back expectations for rate cuts later in the year.
The market nudged up the probability of the Fed hiking rates by a quarter point in May to 61%, from 48% on Friday, and had 38 basis points of cuts priced in by year-end. Fed rate cuts almost certainly might not happen if oil starts creeping higher towards $90 per barrel in coming months.
I’ll say Goldman is right: OPEC+ has acted this way because it knows it can. But however powerful the oil cartel is in moving prices, there’s something mightier: The economy. That is the ultimate leveler of all fanciful schemes.
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Disclaimer: Barani Krishnan uses a range of views outside his own to bring diversity to his analysis of any market. For neutrality, he sometimes presents contrarian views and market variables. He does not hold positions in the commodities and securities he writes about