OPEC+ producers surprised markets with an announcement of voluntary production cuts of 1.15 million b/d. The cuts will take effect in May and continue until yearend, causing oil prices to rise and feeding inflationary fears.
These reductions are in addition to the current official OPEC+ cuts of 2 million b/d announced in October 2022 for the period November 2022 to December 2023.
According to Saudi Arabia, the voluntary cuts are 'a precautionary measure aimed at supporting oil market stability.' Given the current macro environment with the banking sector under pressure, the market may interpret the cuts as a vote of no confidence in the oil demand recovery, which could pose a downside risk to oil prices.
ICE Brent front month had declined mid-March to less than $73/bbl from over $86/bbl early in the month, its lowest since late 2021 amid the recent financial turmoil. After the OPEC+ announcement, Brent crude jumped 5.3% to $84/bbl, marking the sharpest price rise in almost a year.
The production cut will be largely borne by Saudi Arabia, which will cut 500,000 b/d. That is followed by Iraq with 211,000 b/d, the UAE with 144,000 b/d, Kuwait with 128,000 b/d, and Algeria with 48,000 b/d. Kazakhstan and Oman will see cuts of 78,000 b/d and 40,000 b/d, respectively. Russia announced that the existing 500,000 b/d production cut, initially from March to June, will be extended until yearend.
If fully delivered, the announced cut would further tighten an already fundamentally tight oil market, driving the Brent benchmark toward $100/bbl sooner than previously expected and would push the price to around $110/bbl this summer, Rystad Energy said.
The firm added that, from a supply side perspective, the cuts signal the group is willing to defend a price floor well above $80/bbl and prioritize revenue versus market share. Moreover, the fact that these countries are adhering to current OPEC+ quotas, with compliance levels close to 100%, implies that the new cuts will also likely occur.
Meantime, the cuts and resulting crude price action are bound to compress forward refinery margins and run rates. Refineries are coming out of maintenance and run rates are projected to increase by 3 million b/d between March to August to prepare for peak summer demand. Hence, any erosion in crude supply will only make the summer product supply-demand balance tight, with a rally in product prices tracking crude.
Analysts from ESAI Energy said that, with expected higher oil prices following the cuts, some US shale sector rigs that have been idled may find their way back into the field, albeit with some lag in timing. ESAI also believes Europe will call on Arab Gulf producers for more crude oil this summer to replace Russian barrels. The voluntary nature of the new OPEC+ decision will be critical at that juncture, ESAI said.
The market is also concerned that the anticipated increase in oil prices for the rest of the year as a result of the cuts could fuel global inflation, prompting a more hawkish stance on interest rate hikes from central banks across the world. That would, however, lower economic growth and reduce oil demand expansion.