PRE-EMPTIVE STRIKE

The beginning of spring has always been a landmark for the global oil market. This includes a series of events that can fundamentally change the whole situation for both producers and consumers of oil. Suffice it to recall the price war that broke out between Russia and Saudi Arabia in March 2020 and the subsequent agreement signed in April of the same year on a historic oil cut of 9.7 million barrels per day (mbpd)

This year has surprises again. On Sunday, April 2, 9 of the 23 OPEC+ member states have unexpectedly announced a voluntary production cut effective from May until the end of the year, in addition to the commitments made back at the meeting in October last year. Oil ministers of the volunteer countries called it a preventive measure "to support the stability in the oil market". The US did not appreciate OPEC's April joke, calling the decision a bad idea.

Pre-agreed conspiracy

The last time OPEC+ countries agreed in October 2022 to reduce oil production quotas by 2mbpd from the August 2022 levels. This was done in spite of the US insistence to increase production. The quotas were supposed to remain in effect until the end of this year, if the market situation remains unchanged.

However, at the beginning of February this year, Russia, which is under the US and G7 sanctions on oil and oil product imports, announced a voluntary reduction of oil production by 500,000bpd in March compared to February, and then extended the decision for another three months, from April to June. As explained by Russian Deputy Prime Minister Alexander Novak, this was Moscow's response to the sanctions and would help to restore market relations. In the future, Russia will be guided by the emerging market situation, Novak promised. It was not long before Russia reiterated on April 2 its intention to extend the voluntary reduction, now to the end of 2023. This could hardly have caused a stir, if on the same day eight more countries had not announced that they would reduce oil production from May until the end of 2023.

As a result, the total voluntary production cut for May-December will be around 1.66mbpd, with Russia and Saudi Arabia each accounting for 500,000bpd of the deal leaders. Kazakhstan will reduce production by 78K, Iraq by 211K, UAE by 144K, Kuwait by 128K, Algeria by 48K, Oman by 40K and Gabon by 8K barrels daily.

The energy ministers of Kazakhstan and Saudi Arabia said in their comments that this was a precautionary measure "in addition to the production cuts adopted at the 33rd OPEC+ ministerial meeting on October 5, 2022".

The situation came as a surprise to everyone. In fact, back in mid-March Saudi Energy Minister Prince Abdulaziz bin Salman assured that the oil market was now subject to too much uncertainty and volatility, so the only way for OPEC+ to act in such a situation was to maintain the agreement made in October 2022. To the sceptics, who expect a catch at any moment—such as changes to the OPEC+ agreement,—he suggested waiting until December 29, 2023.

Salman later met with Novak, and the two sides underlined the "commitment of the two OPEC+ countries to the October decision to cut production by 2mbd by the end of 2023". In other words, nothing foretold any change, and so the new alliance of voluntary oil production cuts surprised everyone, including the market participants.

Novak explained that today the global oil market is going through a period of high volatility and unpredictability due to the ongoing banking crisis in the US and Europe, global economic uncertainty and unpredictable and short-sighted energy policy. "At the same time, predictability in the global oil market is a key element in ensuring energy security," said the Russian deputy prime minister.

Volunteers do not disclose the baseline production level for oil cuts, but many OPEC+ member states, including Russia and Kazakhstan, have been producing less oil than their quota suggests. So technically OPEC+ has not fooled anyone. Indeed, nothing has changed in the deal itself, that is, the quotas set back in October 2022, as the ministers promised, have not changed. Anything that will be reduced above the set level is an individual and voluntary matter, although agreed in advance. According to WSJ's sources, the negotiations were primarily between Saudi Arabia and Russia, who need to maintain high prices amid the risks of an imminent economic downturn to finance ambitious domestic projects and replenish reserves.

Whether there will be new volunteers from among the OPEC+ member states is still a question. But they have already been invited to join the so-called new club. "Since nine countries, including Russia and Saudi Arabia, expressed their intention to cut production and since OPEC+ consists of 23 countries, we said today that other countries can also join and announce some additional reductions, if they consider it necessary in order to stabilise the market. But these can only be voluntary decisions," Novak said.

In the meantime, there are rumours that in addition to economic reasons to support the global market, the intention is to support Russia in its struggle against the oil ceiling imposed by the West. At the same time, it could also weaken Western countries by reigniting their very painful inflation at a time when inflation has begun to decline. On the other hand, the move can also be prove OPEC+ being in control of the situation.

"This [decision] does not promise anything good. It looks like a small group has pulled off a deal without prior arrangements with others," Commerzbank commodity analyst Karsten Fritsch said.

US disappointment

Predictably, the US reaction was negative. The Biden administration expressed its dissatisfaction with the OPEC+ decision, calling it "inappropriate and irrational". The White House added that the US would work with producers and consumers to manage gasoline prices for Americans.

"We don't think reducing oil production is desirable at the moment, given the unclear market situation. And we have talked about that. We will continue to work with all producers and consumers so that energy markets support economic growth and prices for US consumers come down," said John Kirby of the US National Security Council.

US Secretary of Treasury Janet Yellen also expressed concern about the consequences of sudden oil production cuts by several OPEC+ countries.

Yellen called the decision "unconstructive", which apart from creating uncertainty about global growth prospects, would put a heavy burden on consumers in an environment of high inflation. She said it was important to keep oil prices low, but added that it was too early to say where this would lead to in the future.

There are also concerns that this could deal a new blow to the strained relationship between Riyadh and Washington.

Price scenarios

Oil prices rose by more than 5% overnight amid a decision to voluntarily cut production by OPEC+ member states. The price of Brent and WTI rose to $84.5 and $80 per barrel, respectively. However, the initiators of the cut hardly expected a different reaction from the market. The move strongly surprised analysts and increased fears of inflationary pressures.

At first glance the increase seems unimpressive, but in reality prices returned to the same $80-90/bbl corridor in which they had been during mid-December-mid-March. The benchmark grades then fell below $73 a barrel amid a crisis in the US banking sector and fears that this would trigger a recession in the US economy and negatively impact fuel demand.

"The OPEC+ decision is superimposed on a difficult banking sector, which is expected to lead to tighter credit conditions and slower economic growth," notes IG Australia analyst Tony Sycamore.

The expert believes that rising energy prices will also weaken the economy. In his opinion, OPEC+ production cuts will have a negative impact on stock markets.

"Given the precautionary nature of OPEC's decisions, it is clear that OPEC knows something about demand and supply trends that we have yet to fully discover about the overall supply-demand balance," Christian Malek, head of global energy strategy at JPMorgan Chase & Co.

Fitch Ratings analysts believe that this "increases the likelihood of a market deficit in the second half of the year, especially given recovering consumption in China". The agency predicts that the average price of Brent will be $85 a barrel this year.

But there are also those who see quotes rising to $100 a barrel by the summer and staying at that level for the rest of the year.

According to Rystad Energy, voluntary production cuts by a number of countries will further narrow the oil market, which could lead to prices above $100 a barrel by June. In summer, prices could rise as high as $110 a barrel, they believe.

Goldman Sachs raised its December 2023 Brent price forecast to $95 and December 2024 to $100 a barrel. Among the positive factors, the bank noted China's economic recovery and the sustainability of refinery margins.

SberCIB Investment Research calculates that the price range for Brent could be $80-95 a barrel. "With OPEC+ production cuts, the oil market looks more balanced in the middle of the year, even deficient. Therefore, we believe that prices will remain above $80 per barrel, unless the global economy slides into recession," said Gennady Sukhanov, senior analyst at the group.

He also noted that the Brent price is also driven by factors such as accidents in production, transport capacity, the escalating situation in the Middle East, etc.

At the same time, experts from Citigroup Inc. consider it doubtful that the price will rise to $100 a barrel.

"The uncertainty around oil supply would have to be much more substantial for oil to reach $100 a barrel. There is a scenario where oil is $100 a barrel. But so far, I think it's unlikely," said Ed Morse, head of commodities research at Citigroup Inc. Ed Morse.

For such a scenario to materialise, he said, supply cuts would have to be much more extensive.

Brent and WTI crude futures for June and May are now quoted at $85.12 and $80.7 per barrel.

"There seems to be no way for WTI to leave the $80-per-barrel area, even though the news says the US economy is weakening rapidly," notes OANDA senior market analyst Edward Moya.

Azerbaijan, which is not on the list of the OPEC+ volunteers, is comfortable with the current situation. High prices are boosting oil export revenues. And it is possible to reduce oil production without entering into any agreements. Especially if there is a natural annual decline in oil production.