Did OPEC+ Bring Forward $100 Oil Or Push Back $60?

The unexpected quota cut by OPEC+, mostly representing Saudi Arabia and its Arabian Gulf allies, sent prices up sharply and revived expectations of $100 a barrel before year’s end. Punditry abounds, focusing on everything from Saudi budgetary needs to punishing short-sellers to a desire to stick a finger in Joe Biden’s eye for not opposing Iran strongly enough. Needless to say, nobody really knows the motivation except those involved in the decision, and they are making the usual comments about stabilizing the market. I admit that I would love to see an oil minister just
just
laughingly proclaim that they were bored and wanted to stir the pot.

There is no reason that the decision was based on a single motivation, especially given the many divergent interests in OPEC+, but naturally a desire for more money must rank near
near
the top of the list. Although many moan about the ‘devil’s excrement’ and the ‘curse of black gold,’ the reality is that oil exporters have benefited enormously from their oil income. And with Brent and WTI dropping about $10 a barrel in March and OECD inventories rising sharply in recent months, as the figure shows, the promise of a tight fourth quarter may have seemed ephemeral.

As with the surprise quota reduction last fall, it appears that this was to some degree anticipatory. Falling prices and the growth of short-selling, along with worsening fundamentals, appear to have prompted a pre-emptive strike, as the nuclear missile people say. Which raises the question of why it was necessary to do so, given that they have shown the ability to react quickly to market shifts. Instead, it would seem that a Brent price of $70 a barrel (or WTI of $65) was already too low, especially when the pressure seemed to be bearish, making $70 the new ceiling rather than floor.

This might seem an overreaction given expectations for a tighter market this fall, with the IEA projecting a 1.5 mb/d stock draw in the second half of the year. Others have pointed to weak non-OPEC supply and the potential for a boom in Chinese oil demand to support predictions of $100 by year’s end. Those predictions were moderated after the mini-banking crisis, which raised fears of recession and weaker demand, but the potential for a recession now appears much smaller.

And it is worth noting that the IEA’s projection assumes sharply lower Russian oil production due to sanctions, which to date do not appear to have been effective, or perhaps more effective at lowering Russian oil prices than reducing sales volumes. Russian oil supply data is as questionable as Chinese oil demand numbers, but the threatened production cutback of 500 tb/d in response to sanctions now appears ephemeral, not unlike promises to OPEC of supply reductions in the Soviet days.

There is definitely a good chance that Chinese oil demand will surprise on the upside but the rest of the world seems unlikely to experience a similar boom, meaning bullish pressure on oil prices must come from the supply side of the equation. There should be modest increases from Angola and Nigeria, which have been producing 1 mb/d less than their quotas for some time but where drilling is increasing, such that demand for oil from the core OPEC members will decrease slightly. Relaxation of sanctions against Venezuela could mean 500 tb/d more by year’s end and more smuggling from Iran could add modest amounts to that.

The end result is that rather than the market tightening in the second half, there is at least a 50/50 chance that core OPEC members will need to produce less oil than they did in early 2023, so that the most recent production cuts will prove prescient, just as those last year did.

But the bigger danger is long-term impact, as the fact that despite all of the difficulties with supply from Angola, Iran, Libya, Nigeria, Russia and Venezuela, and expectations of record demand later this year, the price has been under pressure. Worse, U.S. shale oil might experience strong growth, especially with WTI at $75 or above. For companies with costs of $50/barrel, an increase of $10 in the price represents a major boost to free cash flow
flow
and while capital discipline is the byword of the day, it’s not clear if companies will continue with that, leaving cash on the table. With a futures strip above $70 through the middle of next year, and gradually improving supply chains, more investment and supply should be expected.

For many years, the Saudis were seen as ready to bring the hammer down on competitors, including the price collapses in 1986 (after demand for Saudi oil dropped by 75%) and 1998 (when Venezuelan production soared to 1 mb/d over quota). Those promoting high-cost oil substitutes such as methanol would be warned that Saudi Arabia could always undercut them with their rock-bottom oil production costs. Now, the policy appears to have shifted to threatening short-sellers that they could be caught in a squeeze (as just happened), but this inadvertently sends a signal to those afore-mentioned high cost competitors that their business risk is now that much lower.

At least until Saudi policy changes again, and then it isn’t.