Why Opec+ is cutting oil output now

The Opec+ group has shocked oil markets by announcing a surprise production cut of more than 1mn barrels a day, boosting the oil price and raising tensions with western allies.

But why has the oil producer group made this move and what does it mean for wider markets?

Why now?

The simple answer is Opec+, including its largest members Saudi Arabia and Russia, clearly wants to prop up the oil price, or — ideally — push it higher.

Last month Brent crude, the international benchmark, briefly fell towards $70 a barrel as the turmoil in the banking sector led to selling of risky assets. It was closer to $100 a barrel for much of last year.

But the price had already recovered to almost $80 a barrel by the end of last week — not far off where it had traded for much of 2023, and not a low price by historical standards. So analysts see the surprise cut as not just a defensive move by the cartel, but an assertive move by the largest members such as Saudi Arabia.

Saudi Arabia is also frustrated with US comments last week that it will take “years” for it to refill its Strategic Petroleum Reserve, which was partially drained in 2022 to help keep prices in check after Russia’s full invasion of Ukraine.

The US had indicated that while it wanted to stop prices rising too far and would keep pressure on allies such as Saudi Arabia to maintain output, it would also use SPR purchases to put something of a floor under the market.

That was supposed to give reassurances to Opec+ members, who may now feel let down — and are responding by cutting supplies.

Opec+ also does not need to worry too much about conceding market share to rivals. Unlike last decade, US shale output is no longer growing at a rapid pace, so the cartel is less concerned about rivals quickly filling the gap it’s leaving.

Will oil prices rise?

Brent crude oil jumped as much as 8 per cent, moving from near $79 a barrel at Friday’s close to more than $86 a barrel, before tempering slightly.

Traders were already bullish on oil’s prospects for the second half of the year, driven by a stronger global economy combined with China’s reopening from Covid-19 restrictions meaning demand would outstrip supply.

Banks that forecast higher prices are now doubling down. Goldman Sachs raised its forecast for the end of the year from $90 a barrel to $95 a barrel.

Opec+ may hope for higher prices still. Many hedge funds had sold oil during last month’s banking turmoil, as risky assets such as commodities got caught up in a broader market sell-off.

The hope may be that funds re-enter the market now Opec+ has demonstrated its willingness to act.

“The announced cut would further tighten an already fundamentally tight oil market, driving the Brent benchmark towards $100 per barrel sooner than previously expected and would push the price to around $110 per barrel this summer,” said analysts at Rystad on Monday, adding they believed the cut would add “support of around $10 per barrel”.

Does Opec+ fear a recession?

It is possible, and there are some signs oil demand has been slightly weaker than anticipated, particularly in developed countries, in the early months of this year.

The group has called the cuts a “precautionary measure” aimed at “stability” in the oil market.

Citigroup analysts led by Ed Morse said the cuts were aimed at “shoring up a market that was looking increasingly weaker, with faster-than-usual stock builds through the first quarter of 2023”.

But fears of a deep recession have receded in the past six months, partly because energy prices — chiefly European natural gas — fell sharply.

The International Energy Agency forecast an implied deficit of between 1mn and 1.5mn barrels a day in the second half of this year before Opec+’s new cuts.

Is the decision a sign of strained relations with the US?

Helima Croft at RBC Capital Markets said the move demonstrated Riyadh’s commitment to a “Saudi-first” policy as the kingdom becomes more assertive and willing to show the US that it has other allies.

The relationship between the Biden administration and Crown Prince Mohammed bin Salman remains under strain, with the US describing the cuts as not “advisable at this point”.

“It has been apparent that Saudi Arabia is prepared to endure increased friction in the bilateral relationship,” Croft said.

“The bottom line is Washington and Riyadh simply have different price targets for their key policy initiatives,” Croft added, arguing that Riyadh’s “bilateral relationship with China is rising in importance”.

China, however, is not a supporter of oil prices rising too far. Citi expects Beijing could slow oil purchases for its own strategic reserves in the coming months.

Saudi Arabia’s determination to keep working with Russia, which helped form the expanded Opec+ group in 2016, is likely to remain a source of tension with the US. Russia’s own production cuts had already been announced, with many seeing them as a response to western sanctions.

What does it mean for wider markets?

The chief concern will be the impact on inflation. A higher oil price could make it more challenging for central banks to rein in inflation, forcing them to lift interest rates further or keep them higher for longer.

Investors remain divided on whether March’s Federal Reserve rate increase was the last, but they upped their bets slightly on one further quarter-point rise on Monday.

The market’s predicted peak in eurozone interest rates also shifted marginally higher.

But how much oil rises remains to be seen. If the cuts support prices but do not push them towards $100 a barrel, and beyond, the impact could be muted, given crude would remain below levels reached in 2022.

“Oil prices were around $100 a barrel last year and getting $100 a barrel also in 2023 shouldn’t do too much damage, other than possibly add some headwinds to the global economy,” said Bjarne Schieldrop at Swedish bank SEB.