OPEC Just Put a New Floor on Oil Prices. Politics Could Break It.

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OPEC’s latest controversial decision to cut production signals that the cartel has a new price floor for crude—one that might upset the U.S. government but should be very lucrative for oil producers.

Brent crude, the international benchmark, briefly fell below $85 last month, but is now firmly above $90. Raad Alkadiri, an energy expert at Eurasia Group, said OPEC is signaling that a “healthy” oil price is considerably higher than it used to be.

“Their idea of market balance is at $90 to $100,” he said. “They are willing to take proactive measures at a higher price than might have been seen in the past.”

Darwei Kung, head of commodities at asset manager DWS, said that $90 is increasingly looking like a “soft floor” for OPEC.

Oil stocks have surged on the promise of an extended period of higher prices. In the past week, the

SPDR S&P Oil & Gas Exploration & Production
exchange-traded fund (ticker: XOP) is up 11%.

A few years ago, OPEC had seemed comfortable with oil prices trading in a lower range, around $60 or $70 per barrel. OPEC didn’t collectively cut its oil output in 2015 and most of 2016 even as oil prices traded around $50 for much of that period, for instance. 

Part of that may be because Saudi Arabia’s ambitions have changed since then, with Crown Prince Mohammed bin Salman undertaking expensive public works projects, Alkadiri noted. More oil revenue is needed to fund those projects, and if prices crash they won’t be possible. OPEC says it is getting ahead of global economic weakness that will cause oil demand to fall and hurt prices.

Another reason that OPEC seems comfortable cutting production to push prices higher is that the cartel is less concerned with losing market share than it was in the past. In 2015, Saudi Arabia boosted production to take back market share from U.S. shale producers, which had quickly grown production and begun challenging the Middle East’s dominance over oil.

But today, Saudi Arabia is much less worried about losing market share, even though shale production is higher than it was in 2015. U.S. producers are growing production slowly, because they’re trying to assuage investors who would rather they spend money on dividends than on drilling new wells. OPEC officials have even been urging non-OPEC producers to explore more to make up for an expected drop in production in the future. 

OPEC’s production cut is resonating throughout the oil market. A price floor around $90 is incredibly lucrative for U.S. and European oil producers, who are on track to make more than $500 billion in free cash flow this year. 

All that said, the economic rationale for the cut is now being overshadowed by the political implications—and the price impacts of some of the moves being contemplated are much harder to predict.

Several U.S. lawmakers see OPEC’s cut as a provocation to the U.S. and Europe, and a sign of a growing alliance between Saudi Arabia and Russia, which is coordinating with OPEC on oil production. President Biden directly lobbied Saudi Arabia this summer to increase production to ease a global shortage. He called the cut a disappointment.

Others had sharper words. U.S. Rep. Tom Malinowski, a Democrat from New Jersey, and two colleagues introduced legislation after OPEC’s announcement to withdraw American troops and missile defense systems from Saudi Arabia and the United Arab Emirates. They see OPEC’s move as “a hostile act against the U.S.” showing they have “chosen to side with Russia.”

“It is time for the U.S. to resume acting like the superpower in our relationship with our client states in the Gulf. They have made a choice and should live with the consequences,” they wrote in a statement.

The U.S. and Europe are also likely to impose a price cap on Russian oil, a move that OPEC opposes. Russia has threatened to withhold oil exports to countries that impose a cap, which would likely cause prices to spike.

Other pieces of proposed U.S. legislation could also set up a larger confrontation with OPEC. The No Oil Producing and Exporting Cartels Act, or NOPEC, could allow the U.S. to sue OPEC members on antitrust grounds.

Sen. Charles Grassley, a Republican from Iowa, said on Thursday that he plans to try to add NOPEC to a coming military spending bill. “Our energy supply is a matter of national security,” he said in a statement. 

The NOPEC legislation still seems like a long shot, Alkadiri said. But there is a good chance that Biden will look to a more familiar mechanism: releasing more oil from the U.S. strategic petroleum reserve as a way to hold prices down. Reserve releases have worked to hold oil prices down this year, but there are limits to the strategy. The strategic reserve is down to its lowest levels since 1984.

RBC Capital Markets strategist Helima Croft expects any reserve releases to be incremental. “A more clear risk, in our view, is the introduction of U.S. product export restrictions in a rising retail gasoline price environment,” she wrote. Limiting exports would upset Europe, which needs to import fuel, but it would depress the price of gasoline. 

The administration’s response is likely to be determined by how much the oil price increase impacts prices at the pump, Kung said. For now, gasoline prices have begun creeping up slowly, and remain below $4 on average. But with elections approaching, Biden could be quick to act if prices rise more, Kung said. “The current level probably doesn’t justify it,” he said. “I think they are in wait and see mode.”

Write to Avi Salzman at [email protected]