OPEC+ Output Cut Sends A Clear Message To The Market

On Wednesday, October 5th, OPEC+ at its 45th meeting of the Joint Monitoring Committee of Ministers in Vienna agreed to cut daily oil production by 2 million barrels per day. As it was OPEC+’s first in-person ministerial meeting since March 2020, which itself signaled that a major announcement was imminent, it was fitting that the group announced the biggest cut in oil production since the start of the Covid pandemic. The cut, equivalent to about 2% of global daily oil production, was significantly larger than the expected figure of 1 million bpd. However, acc Reuters, as several OPEC+ member nations missed production targets in August, the actual cut is estimated at less than 1 million barrels per day. Given the scale of the move, it’s worth examining the role the company plays in the global oil market and how this latest production cut could affect prices.

The role of OPEC

The Organization of the Petroleum Exporting Countries (OPEC) was founded in 1960 and has 13 members that account for around 82% of the world’s oil reserves and 30% of oil production. While neither the US nor Russia are part of the group, the latter is part of OPEC+, a broader coalition that includes 10 non-OPEC countries with common interests in the oil market. The group, which is unofficially led by Saudi Arabia, sets production targets for its member countries that affect the global oil supply, though its targets are not always met by all members. While there are other influencing factors on both the supply and the demand side, OPEC+ exerts a significant influence on supply and thus on the price of crude oil.

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OPEC has been accused on many occasions of behaving like a cartel, unnecessarily restricting supply in order to maintain high oil export revenues. The group denies this; OPEC Secretary-General Mohammad Barkindo said earlier this year that the organization had “no control” over the rise in oil prices following Russia’s invasion of Ukraine. However, it remains true that the group certainly benefits from high oil prices due to the proportionate importance of oil revenues to OPEC member economies.

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Brent crude oil prices over the last 6 months.

incentives to intervene

Over the past few months, there has been notable price volatility in the oil market, although the overall trend has been down since the second-quarter high of $123.58 a barrel on June 8, as illustrated in the chart above. Over the past 10 days, oil prices have fluctuated between $84 and $90 a barrel and the risk of the oil falling in value further is a key reason for OPEC+’s decision.

A second reason for the cut is the need to improve the spare capacity of some of the main oil-producing nations, notably Saudi Arabia. With the threat of a US-led price cap on Russian oil exports looming, supply is expected to tighten even further, with Saudi Arabia ramping up production again to take advantage of higher prices. By cutting production ahead of a price cap on Russian oil, OPEC+ is also sending a strong message to the US that buyers will not dictate oil prices.

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Russia also has much to gain from higher oil prices. Because of the sanctions imposed on the nation after its invasion of Ukraine, the procurement market in which Russia can sell its oil has been reduced to a few remaining participants. In addition, Russia and Saudi Arabia are likely to benefit more from high oil prices than elsewhere; The nations are the third and second largest oil producers, behind only the US, but their energy revenues are proportionally more important than in the United States’ diversified economy.

The move toward an alliance between Riyadh and Moscow will frustrate the United States. Earlier this year, President Biden reportedly traveled to Saudi Arabia to negotiate commitments to increase the country’s oil production. The trip was particularly significant given Biden’s criticism of Crown Prince Mohammed bin Salman over his alleged connection to the murder of journalist Jamal Khashoggi. This latest OPEC+ announcement casts an unfavorable light on Biden’s trip to Riyadh and increases the pressure on his government ahead of the nation’s midterm elections in November.

Record refining margins

While the oil market headlines will initially be dominated by OPEC+ announcements, another part of the industry to come under scrutiny over the coming months is the refining sector. Refinery utilization rates were unusually high this year and, as noted by Reuterscould remain above 90% in the US for a third straight quarter in Q4 2022. The US has maximized its refining capacity, particularly due to pressure from the Biden administration on the industry to cut domestic gas oil and diesel prices as the midterm approaches.

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Elsewhere in the world, refineries have also been operating at a high level for two reasons. The first is due to capacity losses as plants were forced to close during the Covid pandemic, meaning there is now a lower total amount of global crude refining capacity. The second, more important reason is that refinery margins have grown to record levels this year. This problem was explained by Erwin Seba Reuters: “The margin from selling diesel from a barrel of oil and exchanging that barrel, called the diesel crack spread, this week [26/09/22 – 02/10/22] was about $54 a barrel on the Gulf Coast, compared to about $12 a year ago, Refinitiv said.” This level of profiteering in the refining industry may come under closer scrutiny if global oil prices revisit the $100 mark per barrel rise.

Back in August, Saudi Arabian Energy Minister Prince Abdulaziz bin Salman cited “extreme” volatility as the main reason OPEC may need to step in and protect the integrity of the oil market. Wednesday’s announcement of a 2 million barrels-per-day production cut is unlikely to immediately relieve the oil market of the price volatility seen in 2022, but it could change the broader trajectory of oil prices to point higher again. It remains to be seen whether the Secretary of Energy will remain concerned about market volatility as prices surge above $100.

By ChAI Predict

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