Oil prices jumped to the highest since January as OPEC and allies said they would cut production. WTI May futures surged as much as 8% to $81.67 before trimming gains. The rally came as first Saudi Arabia said it would implement a voluntary cut of 5% of output, or around 500k bpd, and Russia also said it would extend a 500k bpd cut to the end of the year.
Over the past nine months, global oil inventories have moved higher as Russian production proved more durable, Chinese demand was weaker than forecast, and the U.S. released a staggering amount of supply from strategic stockpiles. As a result, market balances moved into surplus in late 2022 and the start of 2023.
By cutting now, OPEC+ moves to rebalance the market in front of the strongest seasonal period. Experts at Third Bridge have been forecasting a deficit in the market for the second half of 2023, and if these voluntary cuts follow through, the expected inventory declines will occur sooner.
“The previous OPEC+ cut, announced last October, did little to stop the negative momentum in the market, but the market setup is different today,” said Peter McNally, Global Sector Leader for Industrial Metals and Energy at Third Bridge. “First, forecasts of Russia’s production collapse in 2022 were premature. Our analysis suggests that Russian volumes will run into trouble during the back half of this year, and this will be an important factor on the market later in 2023. Also, the U.S. has exhausted releases of strategic petroleum reserves, and stockpiles are already at their lowest levels in four decades. Third, Chinese demand remains a wildcard.”
With OPEC+ moving more aggressively to balance the oil market, the alternative sources of supply look limited and the price impact could be material. Starting in the U.S., supply growth has been slowing and the outlook for an acceleration has dimmed. US drilling activity peaked in late November, and the stock market has punished those producers who have committed to more aggressive spending plans.
“The “precautionary measure” will take a collective 1.16m bpd out of the market. It looks like OPEC is getting a bit panicky about demand this year and is trying to create a psychological floor at $80,” said Neil Wilson, Chief Market Analyst at Finalto. “It suggests OPEC thinks the Fed is heading for a hard landing – the banking ‘crisis’ is the catalyst for this move and OPEC wants to get ahead of it. We look to see whether the market unwinds this gap, or whether China demand picks up enough to push the market back towards $100. Because of who is making the cuts it looks like this will be a real supply cut. Momentum in the global economy is the unknown.”
What next for the oil market?
Inflation is going to be harder to tame. Higher energy prices only creates stickier goods inflation – which is supposed to be coming down.
“The Saudis are not afraid of the US – we are seeing a recasting of regional and global dynamics – in light of Covid, in light of US-China tensions, the Biden regime, whatever,” Finalto’s Wilson said. “But we are seeing a new era, as evidenced by the China-brokered Saudi-Iran deal. The Saudis are doing what they need to do and the White House has no say, it seems.”
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What about supply chain bottlenecks?
Third Bridge experts do see some of the supply chain bottlenecks that restrained drilling activity in 2022 easing in the coming months, but the US is unlikely to fill in the OPEC gap anytime soon. Brazil had been expected to be one of the biggest sources of non-OPEC supply growth in the coming years, but the recent political changes there have caused a rethink on future expectations. When looking more broadly, South America represents a unique growth opportunity for companies in the oil industry as resources are growing and access is increasing.
This move by OPEC+ is timed for maximum effect on the market, heading into the summer driving season. “The past six years have shown that the producer group has been more effective at meeting production cuts than keeping up with production quotas in a market seeking more supply,” said McNally at Third Bridge. “A recovery in Chinese demand and a seasonal pickup in the developed world this summer could combine to create sustained upward momentum in oil prices for the balance of 2023. OPEC+ has become a much more nimble organization in recent years, and the organization’s ability to respond to a changing market has been proven time and again.”
Time to close oil short positions?
Temporarily, yes. But the energy bull market we saw last year seems to be running out of steam. Economic slow down in key energy consuming markets is going to exert more pressure on the price than OPEC+ can manage on the upside. We expert a tussle over momentum in the oil futures market in April and into May, with more volatility created as a consequence. But we could see further slippage emerging later in the year.
