Critchlow: “OPEC is playing with fire” following cut in production targets

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At today’s much-awaited meeting, OPEC+ members agreed to cut oil production quotas by 2 million barrels per day (bpd), much to the irritation of the Biden administration.

The decision came shortly after the Joint Ministerial Monitoring Committee (JMMC) of the OPEC+ group advised the cut, just five weeks ahead of the all-important mid-terms in the US.

In economic news, there are many factors causing havoc around the globe, including the accelerated rate hikes in the United States, the crisis in Europe, and a deep slowdown in China.

Given these issues, demand for crude oil is expected to decline in the coming months, particularly in 2023.

Weighed down by a strong dollar and recessionary expectations, Andy Critchlow, Head of News for EMEA at S&P Global Commodity Insights believes,

OPEC is moving quickly because they see this market shrinking before them.

Bloomberg’s Julian Lee agrees,

They were very concerned by oil priced below $80 a barrel. They want something which is much closer to $100, and they’re acting to get it.

Oil prices have risen in the past two days on expectations of a supply cut, gaining roughly $5 – $10 per barrel over two sessions.

However, the actual supply reduction will not be equal to 2 million bpd as the majority of producers are unable to meet their targets in any case.

During the month of October, OPEC countries and non-OPEC countries had targets of 26.689 million bpd and 17.165 million bpd, respectively. Collectively, they fell well short and were estimated to be about 3.6 million bpd below the agreed-upon quotas.

Source: S&P Global Commodity Insights

In such an environment, Lee estimates that production will likely fall by 800,000 – 900,000 bpd.

Geopolitical implications

Reports suggest that Saudi Arabia whose production hovers near its quota (and is arguably the US’s most important ally in the Middle East), is expected to see a reduction of half a million bpd in its target if cuts are distributed proportionally.

This would constrain production in the country and signals that the Saudi Arabian government is shifting away from the US.

Critchlow added,

…OPEC’s playing with fire…the geopolitics around this are probably the most complicated I have ever seen.

Undoubtedly, the resilience of OPEC+ amid the Russia-Ukraine war, sanctions on Moscow, the deliberate sabotage of the Nord Stream pipelines, and reports of unidentified drones in the vicinity of Norwegian offshore oil and gas facilities, have been a source of much frustration for the Biden government and may force a permanent divide between Saudi Arabia and western nations.

If that weren’t enough, the mercury has been rising even further with the presence of Alexander Novak, Deputy Prime Minister of Russia, who co-chaired the OPEC+ meeting and is himself under sanction by the US government.

For the US, which has tried to maintain a channel of communication with the Saudi government throughout the year, this is certainly a cause of embarrassment and a case of rather unfavourable optics.

The kingdom has effectively stepped right into the middle of a geopolitical contest between the US and Russia.

US concerns

For the US in general, and President Biden in particular, this is an uneasy moment,  with the mid-terms approaching shortly.

Crucially, the US Strategic Petroleum Reserve (SPR) is expected to run its course by the end of October and would require to be topped up again. This would prove to be an increasingly expensive proposition.

Critchlow noted,

…(The US) will have to pay a lot more money for refilling those reserves.

Moreover, in some parts of the country such as California, gasoline prices have been around the $5 mark again, threatening to plunge at least select states into a similar crisis as earlier in the summer.

Even though the entire quantum of 2 million bpd is not expected to come off the market, for the Biden administration, it is a case of disappointing optics in which it looks relatively ineffectual and may soon be faced with price pressures in the gasoline market.

Outlook

Saad Rahim, Chief Economist for Trafigura anticipates that interest rate hikes (should they continue) will dissuade investment in crude oil portfolios, keeping prices below $100 per barrel this year, but expects a supply crunch and sharp price rise in 2023.

Prices could rise further this year themselves if geopolitical factors begin to deteriorate.

Europe is reeling under a major energy crisis, and a reduction in supply will only lead to higher natural gas prices (which I reported on in an earlier article).

The Russians themselves would be eager to push the price significantly higher, with S&P Commodity Insights estimating their break-even price at $129.4 per barrel.

At the time of writing, in commodities markets, Brent crude was trading 1.4% higher on the day at $93.3 and WTI was 1.2% higher at $87.8.

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