Was that OPEC oil production cut all for nothing?

So has the OPEC oil production cut been for nought?

At the start of April when OPEC unexpectedly announced that it would curtail output between May and the end of this year it triggered a sharp rally in oil prices and heady talk of prices rising to $100 a barrel. But the dramatic increase seems to have lasted only a few weeks and we are now back in the same territory as before the output cut decision.

After OPEC’s announcement Brent crude prices rallied roughly 11% to $87/bbl but this week they are trading back at between $77-$79/bbl, barely changed from the end of March.

That is because the state of the global economy and the main oil-consuming regions is really not strong enough to support this kind of increase in the oil price.

At 102 million barrels per day, global demand is by no means weak. It is growing by about 2% per year on the back of stronger demand from China as the country bounces back after Covid. But looking at forecasts for GDP growth, a rough guide to likely oil demand growth in the main consumer regions, the US, Europe and China, the numbers don’t add up.

The US is still the world’s largest buyer of oil and accounts for more than 20% of the world’s total consumption. The EU consumes almost on a par as the US while China buys 13.2% of global oil. US economic growth is currently at 1.1%, the EU is barely moving at 0.1% while China, in contrast, is on track to grow at around 5% this year.

China’s economic recovery is a little bit uneven, with retail buying bouncing back with a vengeance, while exports, one of the driving engines of growth over the previous years, are facing headwinds. Europe, one of China’s main export markets, is barely staying out of a recession, and political decisions protecting domestic producers are also beginning to play a role. The US has brought in similar rules which will limit some imports from China and the cumulative effect of those sets of regulations will be felt over the coming months. This means that the fast Chinese economic growth seen in the last two decades will remain in the rear-view mirror.

Oil markets

Brent crude forward positions in the futures market indicate that traders are confident that there won’t be any serious shortage of crude oil in the months ahead. Futures prices are indicating that the oil market is currently a little weaker than usual at this time of the year but spreads between months are indicating the opposite.

Brent’s six-month calendar spread is now in a backwardation of $2.40 per barrel. This is likely because current demand is slightly weaker than normal but is expected to pick up later this year, particularly during the summer driving season in the US.

Looking at the Commitment of Traders in the oil market, OPEC’s decision did have one significant impact in that it seems to have forced bearish hedge funds out of the market. But will this be enough to sustain higher oil prices? Unlikely.

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