Why OPEC+’s Oil Production Cuts Aren’t What They Seem

On Wednesday, oil futures spent some time trading lower not long after news of the decision, then moved up more decidedly after the Energy Information Administration reported weekly declines in U.S. crude, gasoline and distillate supplies.

Futures prices for global benchmark Brent saw its December contract settled at $93.37 a barrel, up $1.57, or 1.7%, on ICE Futures Europe, on Wednesday. U.S. benchmark West Texas Intermediate crude for November delivery added $1.24, or 1.4%, to $87.76 on the New York Mercantile Exchange.

Based on front-month prices, both Brent and WTI settled at their highest prices since mid-September.

“Given that the group has been producing significantly below its quota, the decline in physical supply will be much less, though still significant,” Caroline Bain, chief commodities economist at Capital Economics, wrote in a report issued after the OPEC+ decision. Capital Economics estimates that the decision will result in a cut of just over 1 million barrels per day, or about 1% of global supply, she said.

The Organization of the Petroleum Exporting Countries and their allies, referred to as OPEC+, said the cut would begin in November and that the downward adjustment would be based on the August 2022 required production levels.

In reaction to the move, U.S. President Joe Biden said he is “disappointed by the shortsighted decision” to cut production quotas while the global economy is dealing with the continued negative impact of Russian President Vladimir Putin’s invasion of Ukraine.

OPEC+ said it will no longer hold monthly meetings and instead meet every six months, though its next gathering is set for Dec. 4. The OPEC+ Joint Ministerial Monitoring Committee (JMMC), which reviews the oil market, will meet every two months, instead of monthly.

In a press conference after the OPEC+ decision, Prince Abdulaziz bin Salman, Saudi Arabia’s energy minister, said that the group will continuously prove that OPEC+ is “not only here to stay,” but here to bring out stability for the oil market.

“OPEC cited the uncertain outlook for the global economy as the main reason for the quota cut,” said Bain. “However, the plunge in prices since their peak in March no doubt played a role.”

She also said “the market backdrop is somewhat unusual for a supply cut,” with global oil stocks “historically low and, so far, high prices have failed to materially dent demand.”

The output reduction itself marks the largest output cut since the start of the COVID-19 pandemic as worries of a potential recession raised the risk of a slowdown in energy demand.

“The shift from OPEC+ to now hold their meetings physically for the first time since the start of the pandemic has also caused speculation that a significant policy shift is in the works,” said Srijan Katyal, global head of strategy and trading services at international brokerage ADSS, in emailed commentary. “This could be a sign that OPEC+ is systematically reducing production given the decreased demand for oil amid the weakening global economy.”

OPEC+ production totaled 42.84 million barrels per day in August, an increase of 260,000 barrels per day from July, according to a Platts survey by S&P Global Commodity Insights released in early September. The report on the survey said that was the most since the alliance opened the taps to produce 47.56 million barrels per day in April 2020, “during a brief price war in a dispute over pandemic strategy before historic cuts were subsequently agreed.”

However, the 19 countries with quotas under the OPEC+ agreement fell 3.61 million barrels short of their production targets in August, “the widest gap in the alliance’s nearly five-year history,” according to S&P Global Commodity Insights.

Tom Kloza, global head of energy analysis at the Oil Price Information Service, a Dow Jones company, said that the OPEC+ cut ultimately only amounts to 800,000 barrels to 900,000 barrels a day since “many cartel members do not have a reasonable capability of hiking output.”

Then again, with the pending end of oil sales from the U.S. Strategic Petroleum Reserve, “one could say that it leads to about 1.9 million [barrels a day] less crude on the market,” with SPR sales around 1 million barrels per day and OPEC committing to a cut that’s about 850,000 barrels a day in real terms.

Kloza said there’s no big impact on gasoline or diesel at the moment, as those products “have their own ecology.” The huge gas price increases in California are over, he said, but refinery work and downtime in the Midwest need to be followed.

For now, it seems likely that the OPEC+ production cut “will just deepen the small deficit we forecast in the fourth quarter,” Capital Economics’ Bain said.

“We had always expected supply growth to slow later this year and into 2023, but this latest OPEC+ action has re-enforced our view that prices will end the year a little higher, at $100 per barrel for Brent” and $92 for WTI, she said.

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