Global debate on growth turns crude on OPEC+ oil cut

Key takeaways

• Production cuts announced by OPEC+ have brought oil prices temporarily back to around USD 80/bbl, after they had dipped in March on expectations of slowing global growth
• OPEC+ seeks to keep prices within a relatively tight band, with Saudi Arabia’s budget using USD 75/bbl as a benchmark. We expect Brent crude prices of around USD 90/bbl by year-end
• We do not expect slightly higher oil prices to halt the global disinflationary trend
• We maintain a neutral exposure to a diversified basket of commodities and the energy sector.

A cut in OPEC+ crude oil output should not have surprised markets, even if its timing did. The reduction falls on an oversupplied oil market as global demand shows signs of slowing. Saudi Arabia’s domestic budget depends on a barrel of crude priced at around USD 75, and recent financial turmoil has resurrected investors’ focus on the prospects of a US recession, causing a slide in the oil price.

The price of Brent crude fell as low as USD 73 per barrel (/bbl) in March 2023, its lowest level since December 2021, reflecting worries that contagion from the banking sector would undermine global growth and demand for energy. Exacerbating oil oversupply, last month the US government announced a plan of releasing crude from its strategic reserves in Q2 2023, and the French government dipped into its supplies to counter the impact of labour strikes. Global production of crude has been consistently around 100 million barrels per day (bpd) since mid-2022 (see chart 1).

OPEC+, the Organization of the Petroleum Exporting Countries plus Russia, announced a proactive cut of 1.15 million bpd to oil production on 2 April, effective from May 2023 until the end of the year. Half of that cut will be made by Saudi Arabia, which described the move as a “precautionary measure aimed at supporting the stability of the oil market.” Since the announcement, the price of oil rose to around USD 85/bbl, before falling back to around USD 80/bbl. Consensus analyst estimates for the price of crude at the end of 2023 now sit around USD 93/bbl. Our estimate is USD 90/bbl.

In practice, the cartel may struggle to implement such cuts. As recently as October 2022, OPEC+ announced a two million bpd production cut, but has delivered only around half of it. Some of the group’s members, including Iraq, are already producing less than their quotas as their output is hampered by a lack of investment. Russia, OPEC’s ‘plus’ member, reduced output by 300,000 bpd in March, compared with a 500,000 bpd target. As a result, markets estimate that this most recent OPEC+ cut will translate into a net drop in production closer to 700,000 bpd, which means in total around one million bpd less flowing to the market from OPEC+ from May.

The most recent financial turmoil reminds us that what happens in Silicon Valley does not stay in Silicon Valley. Crises always impact oil markets. Recently, markets have worried that banking stress will exacerbate a global economic slowdown, reducing demand for oil. The Covid pandemic and its aftereffects were the most dramatic recent examples of a shift in demand, pushing the price of a barrel of crude to a high of USD 122 in June 2022. As during the Great Financial Crisis of 2008, such prices clearly undercut demand for crude.

Taking on shorts

Meanwhile, the Organization said that speculative, short-selling positions on oil, where traders bet that the price of crude will drop, had accumulated to the extent that even news of lower deliveries failed to move prices far (see chart 2). There is some precedent for OPEC+ taking on short positions. In September 2020, Prince Abdulaziz bin Salman Al Saud, Saudi Arabia’s energy minister, pledged that traders who shorted the oil market would be “ouching like hell.” At the time, a barrel of Brent crude traded around USD 43/bbl.

OPEC+ seeks to keep prices within a relatively tight band. The relatively high ‘floor’ price of around USD 80 per barrel suggests that the cartel is targeting an oil price between USD 80-90/bbl, which is a range that is fiscally sustainable for Saudi Arabia, while avoiding demand destruction. The country’s budget, and plans to reduce its economy’s dependence on oil, assume a long-term average crude price of around USD 75/bbl (see chart 3). Refining margins, the difference between the price of crude and its refined products, have declined but remain relatively high at between USD 25-30/bbl.

On 5 April 2023, three days after the OPEC+ announcement, ratings agency Fitch upgraded Saudi Arabia’s debt rating to ‘A+’ (from ‘A’), with a stable outlook, on the grounds that the kingdom enjoys “strong fiscal and external balance sheets” and “some indications” that its dependence on oil is improving. Saudi Arabia posted a budget surplus in 2022, its first since 2013, thanks to higher oil prices.

Still, if the supply of crude from non-OPEC members were to grow, then the cartel’s output cut may look like a repeat of the policy mistakes of the 1980s. Then, after a series of oil ‘shocks,’ the Organization had to abandon its efforts to reduce output as it stimulated supply from rivals, including the US. Currently, OPEC+ accounts for a little less than 40% of the world’s oil production but its members sit on as much as 80% of global reserves. Yet it seems likely that with ‘peak oil production’ imminent in the next few years (estimates vary), US shale production has already peaked, while many other oil producers have underinvested in production facilities. Today, the challenges facing OPEC+ look very different, as economies work to shift their energy consumption to more sustainable alternatives.