Oil Update: OPEC+ Announces Further Production Cuts

Summary

• OPEC+ announced further cuts in oil production of 1.2mn b/d from May until the end of the year.
• We see limited impact on actual supply as OPEC+ is already underproducing relative to their existing quota.
• OPEC+’s ‘precautionary cut’ confirms demand is undershooting their expectations so far in 2023.
• We still expect oil to be rangebound to slightly higher following the rally over the last week.

Limited Impact on Actual Supply

OPEC+ announced further cuts in oil production of 1.2mn barrels a day (b/d) – about 1% of global oil supply – from May until the end of the year. The cuts total 1.6mn barrels when including the extension of the 0.5mn b/d cut announced by Russia last month.

The move surprised the market as OPEC+ delegates indicated to Reuters just last Thursday that changes to its existing supply quota were unlikely following the 2mn b/d cut announced last October.

Chart 1 shows the breakdown of the 1.2mn b/d by country.

However, we believe the impact on global supply is likely far lower than the 1.6mn b/d indicated by OPEC+.

The main reason for this is that OPEC+ has been underproducing relative to the existing quota announced last year. Following the announcement of the 2mn b/d cut in October, OPEC+’s production ‘quota’ fell to around 25.4mn b/d while three-month production averaged around 24.5mn b/d at the end of February.

This means the actual level of cut required by ‘OPEC 10’ members in totality to fulfil the new announcement is around 0.1mn b/d.

Another reason is that interpreting Russia’s statements about production cuts has become harder.

For instance, despite Russia committing to a production quota of 10.5mn b/d in November, its total liquids production has remained strong at around 11mn b/d over the last three months. Also unclear is whether its production cuts would directly impact crude exports or just result in less demand internally.

We think supply cuts are more likely to be in the 0.8-1.0mn b/d range based on announcements from the larger ‘OPEC-10’ members while including some reduction in Russia’s production due to the uncertainty involved.

Cuts Confirm Environment of Weaker Demand Growth

The announcement of cuts on a ‘precautionary’ basis confirms that OPEC+ believes we are in an environment of weaker demand growth.

Weaker industrial activity is consistent with weaker distillate fuel demand, which is capping the oil price despite higher gasoline and jet fuel demand in China.

Indecision Around SPR refill to Likely Drive Supply Cuts

OPEC+ members also hinted that their decision was driven by the US’ indecision/lack of commitment to begin meaningfully refilling the SPR this year despite WTI falling within their desired range of $69-$72 a barrel.

US Energy Secretary Granholm stated that meaningfully refilling the SPR this year ‘could be difficult’ in an interview on the 24^th of March, before pivoting slightly last week by indicating purchases could start in Q4 this year.

The lack of commitment is likely to frustrate OPEC+ members. It adds further instability in the market by effectively removing the SPR put when oil prices fall, adding to price volatility while demand growth is subdued.

Market implications

We believe oil prices will remain broadly rangebound to slightly higher over the next few months at c.$80 a barrel on WTI.

The supply cuts announced are unlikely to result in a large spike in the oil price given the ongoing demand environment. However, we think the probability of a sharp fall in WTI is limited given the better balance between demand and supply relative to Q4 last year.

Therefore, the impact on monetary policy is likely to be limited in the near term. Policymakers can look through the initial reaction and continue to focus on core services inflation and financial stability risks in the months ahead.

Viresh Kanabar has worked in the UK financial services industry for over 8 years including in Consulting and Investment Risk. Most recently he launched The Macro Journal Substack where he puts out regular in-depth reports covering all areas of global macro.

Photo Credit: depositphotos.com

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