Why Did OPEC Cut Production For October Targets?

Key takeaways

• On Monday, OPEC announced that it would slash oil production targets for October by 100,000 barrels per day
• The group of oil producers expressed concerns over weakened demand, slipping prices and a potential Iranian nuclear deal
• Brent crude futures have fallen from their March high of $147 to around $96 a barrel

On Monday, the Organization of the Petroleum Exporting Countries (OPEC) shocked the oil market when it announced plans to reduce October oil production. OPEC+ (which includes OPEC and allied oil-producing nations like Russia) agreed to shave some 100,000 barrels per day (bpd) off next month’s production targets.

Monday’s announcement is unusual because it marks the first intentional output decline since the middle of the pandemic. The move also effectively rolls back the production increase OPEC agreed to last month by the same number of barrels. A statement from OPEC+ notes that the group agreed to the 100,000 bpd adjustment “only for the month of September.”

According to U.S. Energy Information Administration data, OPEC members produce around 40% of the world’s crude oil. However, OPEC members export about 60% of the total globally traded petroleum by volume. Thanks to their market dominance, OPEC decisions can greatly sway oil prices, in turn impacting consumers and investors.

But the question remains: why did OPEC cut oil production?

Why did OPEC cut oil production?

OPEC is an international group of oil-producing countries led by Saudi Arabia. The group has recently raised alarm over recent oil price declines, as well as weakened Chinese demand as Beijing continues to grapple with nationwide Covid lockdowns. But mere price worries may not be the only factors at play.

“Exaggerated” price declines

Last month, Saudi Arabia raised the prospect of slashing output to address what it considers “exaggerated” oil price movements. The country has signaled it’s prepared to preempt downward pressure on oil prices to protect profit and maintain market stability.

Long-term decline predictions

In its August market report, OPEC estimated that global crude oil demand would fall by around 300,000 bpd in both 2022 and 2023. And last month, the International Energy Agency (IEA) noted that sudden demand spikes borne out of easing pandemic restrictions are set to drop in Q4.

Together, these indicators suggest that major oil and energy producers are preparing for demand to drop. OPEC’s production cuts may partly be the first step to prop up prices under that eventuality.

A potential Iranian nuclear deal

But OPEC’s decision may also be a signal – specifically, to world leaders that would make a deal with Iran.

Recent oil price drops have been pegged to anticipation of a potential supply boost from Iranian crude returning to the market. Currently, Tehran is petitioning global powers to revive its 2015 nuclear deal. If a deal materializes, Iran could bolster global oil supplies by 1 million bpd, or 1% of global demand.

As a member of OPEC+, Iran’s return to the market could grant the group more leverage over the oil markets. However, Iran is also a rival of Saudi Arabia – and if Iranian oil floods the market, the kingdom’s influence over oil prices could falter.

That’s the position of Tamas Varga, who works for oil broker PVM. Varga said in a statement: “The political angle, it seems, is a Saudi message to the U.S. about the revival of the Iranian nuclear agreement…. It is hard to interpret the decision as anything but price supportive.”

Russian sanctions

Another factor that could play into OPEC’s decision is the ongoing sanctions against Russia for its military actions in Ukraine.

Just days ago, Russia, a co-leader of OPEC+, announced plans to indefinitely shut off a key natural gas pipeline to Germany. Russia has also threatened to suspend oil supplies to countries that support a price cap on Russian oil exports.

While Russian oil production fell only one million bpd short of July targets, that’s likely enough to bite given the country’s unstable financial situation.

A message to the world

Ultimately, slashing global oil production by 100,000 barrels per day is little more than symbolic. That number represents just 0.1% of global output and will have little real impact on supplies. Not to mention, many OPEC members continue to produce well below oil production quotas.

Instead, it appears that the reason OPEC cut oil production has more to do with sending a message – or two – to the world.

One message is that it’s prepared to defend its profits. Noted Bill Farren-Price, head of macro oil and gas at market research firm Enverus: “[The production cut] shows that OPEC countries have gotten used to $100 [per barrel] oil. Despite the recession risks that are mounting, they are not prepared to give that up without a fight.”

OPEC+ reiterated this idea in a post-meeting news release, stating that the group has “the commitment, the flexibility and the means” to handle “higher volatility and increased uncertainties” in oil markets.

The second message is more direct: by trimming production to support prices, OPEC+ demonstrates that it’s willing to ignore the Biden administration’s requests to boost production and help bring down the price of gasoline. Though President Biden visited Saudi Arabia in July to lobby for cheaper oil, the decision to slash production sends a clear message: revenue is the name of the oil game.

Richard Bronze, head of geopolitics at market research firm Energy Aspects, supports this position. He noted that OPEC’s oil production cut “sets up a confrontation in terms of expectations of Western developed economies versus the Gulf States.”

Oil and you: how OPEC cutting production hits investors

Already, OPEC cutting production has impacted investors.

Brent crude futures, the global benchmark for oil prices, saw increased volatility Monday morning, trading up 3.6% to $96.40 per barrel. By Monday afternoon, futures were up around 2.5% to $95.54 per barrel. Meanwhile, U.S. West Texas Intermediate futures climbed 2.6% to $89.16 a barrel.

For oil investors, these prices provided some slight relief off recent activities. Since early June, global oil prices have plunged over 20%. In the United States, oil prices dropped 7% last week alone. Gas prices have also fallen, with the national average falling from over $5 per gallon in June to just $3.79 on Monday.

These numbers have set some anxiety percolating in the oil markets as producers worried that sharp economic slowdowns and recession woes in China, Europe and the U.S. could sap demand. Inflation, interest rate hikes, ongoing Covid restrictions in China, and a stronger U.S. dollar have all contributed to these worries.

Going forward, OPEC’s decision to cut oil production may have little impact on the markets beyond providing price support. (Unless, of course, the group agrees to slash production further.) The move appears largely symbolic, but that may be enough to buoy oil prices and keep investors in the black in the face of economic uncertainty.

Why OPEC cut production matters less than what you do about it

No one investor can affect OPEC’s decision to slash (or boost) oil production. But every investor can benefit from the group’s decision with a few savvy investments.

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