OPEC+ just made the Fed's job more complicated. Here's why they did it — and what could be next
OPEC+ members have decided to cut oil supplies, adding to the global challenge of reining in firm inflation rates.
The Key Points
Monday's formal meeting of an OPEC+ Technical Committee will be held to review the group’s current strategy. It cannot alter policy.
Several OPEC+ member countries are planning to increase global production by 1.16 million barrels per hour until the end. This will further complicate central bank efforts to curb global inflation, but also protect the alliance's wider output strategy from political pressures.
Washington has criticized Sunday's announcement by eight OPEC+ producers, including Saudi Arabia as group leader and key allies Kuwait & the UAE. They announced that they would remove more global oil markets than a total of 1 million barrels per hour in an independent initiative that is not linked to the broader OPEC+ strategy.
This addition to Russia's already existing intentions to reduce 500,000 barrels per daily of its own production, from February output levels now through the end of 2013, brings the total voluntary reductions of OPEC+ member countries to more than 1.6 million barrels/day.
According to Reuters, a spokesperson for National Security Council stated that cuts were not advisable given market uncertainty.
The administration of U.S. President Joe Biden has repeatedly criticized OPEC+ for its production cuts. They cited the inflationary toll on families and made accusations of friendship with Russia. Production cuts lead to lower supply which in turn causes higher prices at the pumps in importing countries, which in turn boosts headline inflation figures.
At the end last year, relations with OPEC+ chair Saudi Arabia descended into a war over words. The oil group had agreed to a 2,000,000 barrels per day reduction until 2023. This decision was upheld by ministerial as well as technical committees.
The OPEC+ Joint Ministerial Monitoring Committee is scheduled to adjourn at noon Vienna time Monday. It could recommend no production changes. However, several OPEC+ delegates informed CNBC that they prefer to remain anonymous because of professional restrictions.
The end of formal group action is unlikely. Front-month Brent futures prices rose by $4.44 per barrel from Friday's settlement to $84.33 per barrel at almost 10 a.m. London. Analysts are now warning of prices reaching $100 per barrel. Goldman Sachs could increase Brent forecasts by $5 to $95 per barrel for December 2023.
"The expected rise in oil prices over the next year due to these voluntary cuts could fuel inflation. This would prompt a more hawkish stance by central banks around the world on interest rate increases. However, this would lower economic growth and decrease oil demand expansion," Victor Ponsford, Rystad Energy, stated in a research paper.
Oil prices jump after OPEC and its allies announce a surprising output cut
Tamas Varga of PVM Oil Brokers, raised the larger political risks associated with the voluntary cuts and told CNBC that the headline inflation should rise quicker than expected.
He said that central banks may not stray from their course of slowing down the increase in borrowing because their views are primarily shaped by core inflation figures. These numbers will not be as affected by higher oil prices as headline data.
"The US Congress will hear louder the voices of those who support the NOPEC bill and will accuse OPEC+ of using oil as a weapon. This is a bullish move, as supply worries have overtaken macro concerns. This move will also cause further deterioration of the Saudi-US relationship.
The NOPEC -- No Oil Producing and Exporting Cartels - bill is a proposed U.S. law that would allow OPEC+ members to take antitrust legal action.
The U.S. can try to reduce price rises by releasing additional volumes from its Strategic Petroleum Reserves. One anonymous OPEC+ representative stated that Washington has obstructed its fight against inflation through blocking global access Venezuelan and Iranian volumes. Meanwhile, EU countries refrain from buying Russian goods out of solidarity with the invading Ukraine.
OPEC+ delegates also criticized the windfall taxes that western countries impose on energy companies. They claim they were not given any consistent support when WTI futures traded negative in April 2020.
Recent OPEC+ pronouncements have focused on the issue of spare capacity. The group intervened to preserve the attractiveness of long-term investments in oil projects and the stable return they offer. Nearly all countries that participated in the announcement of independent cuts have additional capacity.
An anonymous source from OPEC+ said that discussions to coordinate additional independent cuts began towards the end of last week. This was when volatility in the banking industry following the failures by several U.S. lenders and Swiss lenders eroded investor trust in historically volatile assets like oil. OPEC+ delegates previously stated that the impact on oil from the banking turbulence will be temporary, with longer-term concerns lingering about the looming demand for a reopening China as the world's biggest consumer.
"What happened to oil prices over three weeks had nothing to do oil factors. It was all to do the banking crisis and the fears it brings. "We also saw a large, massive increase in the [the] short-market, which is something that OPEC are keen to stomp on," Amrita Sen, cofounder and director, research at Energy Aspects told CNBC's Dan Murphy.
When they anticipate price or market declines, investors tend to take short positions.
"I believe that if the market tightens or exogenous shocks or issues fade, they will reverse the cut." This is not a set-in-stone plan for the remainder of the year. However, it clearly defends a floor.
It is easier to reach an agreement and unwind voluntary production moves without affecting domestic or international OPEC+ politics. These cuts were previously accepted by the group provided that they were consistent with existing OPEC+ policies. However, they typically represent the initiative of one country and exclude temporary Saudi-Kuwaiti–UAE reductions during the Covid-19 pandemic.
The coordinated gesture of Sunday's magnitude creates a second, informal agreement on top the existing formal OPEC+ Strategy. This is easier to defend when individual oil ministry faces pressures from their governments or state oil companies to increase production and short-term revenue. Independent cuts can be made without the approval of all OPEC+ members and are therefore not subject to external accusations of anti-consumer organized behavior.
However, the gesture won't bridge the political rift that is growing between OPEC+ kingpin Saudi Arabian and the Biden administration, whose influence in the Middle East has been steadily supplanted China. Beijing has helped to rekindle relations between Iran and Riyadh over the past month. Saudi Arabia is also considering joining the China-led Shanghai Cooperation Organization (DIYO) as a partner in dialogue.
Andy Critchlow (EMEA head for news at S&P Global Platts), stated that "[the organized voluntary cuts] certainly would contribute to the narrative that America is losing its power in the region to influence the actions of core OPEC producer like Saudi Arabia and UAE which have historically been client states of the U.S."
This cannot be seen in isolation from the larger geopolitical context in the Middle East which is seeing the core oil producers move closer to China and Russia. They prefer to operate in a multipolar world than being tied to the U.S. dependency."