In a surprise announcement on Sunday 2 April, several OPEC members said, starting 1 May, they will cut oil production targets by 1.16 million barrels per day (mbd) relative to February levels.1 These cuts add to the 0.5mbd reduction in targeted Russian output announced in February and which the Kremlin has now extended until the end of the year. In total the planned cuts amount to 1.7% of global oil supply. Brent and WTI prices rose about 7% following the announcement, returning to levels prevailing before recent banking sector turmoil and much lower than in the aftermath of Russia’s invasion of Ukraine.
Investment Insights • MFN
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Surprise output cuts reveal OPEC+’s red lines
On 2 April, several OPEC+ countries announced cuts to oil output targets, to take effect from 1 May. Oil prices surged on the news but remain well below the peaks seen after Russia invaded Ukraine. In this Macro Flash Note, GianLuigi Mandruzzato looks at the outlook for the oil market and concludes that the oil price rebound is unlikely to last.
Figure 1. Oil prices (USD per barrel)
Source: EIA, IEA, OPEC, Refinitiv and EFGAM calculations.
The moderate market reaction probably reflects the fact that an announcement was expected anyway at the latest at the next OPEC+ meeting on 4 June. According to estimates by the International Energy Agency (IEA) and the US Energy Information Administration (EIA), the physical oil market has experienced an oversupply since 2022Q3 that was expected to continue until mid-2023. Starting in 2023Q3, economic recovery in China and lower supply from OPEC+ were expected to cause oil demand to outpace supply moderately. The announced OPEC+ target production cuts are broadly aligned with this scenario.
Another reason behind the moderate market reaction is that the actual impact of the OPEC+ targeted supply cut is uncertain. Last October, a 2 mbd cut in production quotas was followed by a drop in production of less than 0.6 mbd. In February, OPEC+ production was 1.72 mbd below target according to IEA data. In contrast to October 2022, this time the planned production cuts were announced by countries that are already meeting or exceeding production quotas, suggesting that, following the cuts, actual OPEC+ supply will be closer to the new targets.
Figure 2. OPEC+ production shortfall (mb/d)
Source: EIA, IEA, OPEC, Refinitiv and EFGAM calculations.
Finally, it is notable that OPEC+ acted only after the price of oil fell below USD70 per barrel, a level about 15% lower than when it last cut production quotas. This suggests that prices in the range of USD70-80 per barrel are seen as adequate by oil-producing countries. It may be no coincidence that the IMF estimates Saudi Arabia needs a price of oil around USD 70 per barrel to balance its budget.
With the cuts announced on 2 April, oil supply and demand should return close to balance in the second half of 2023. Furthermore, the quota reductions signal that oil producing countries aim to keep prices above USD70 per barrel. However, high inventory levels built up in recent months and persistent uncertainty about oil demand will continue to weigh on prices. It would not be surprising if OPEC+ were required once again to support prices in the coming months to ensure the USD70 floor is not breached.
Figure 3. US commercial petroleum product stocks
Source: EIA, IEA, OPEC, Refinitiv and EFGAM calculations.
1 Seven OPEC+ countries announced cuts to oil output: Algeria (0.048 mbd), Iraq (0.211), Kazakhstan (0.078), Kuwait (0.128), Oman (0.04), Saudi Arabia (0.5), and the United Arab Emirates (0.144). The cuts will be in place until the end of 2023.