OPEC Cuts Oil Production
On April 2nd, OPEC+ shocked markets by announcing a production cut of more than 3 million barrels per day (bpd), in a move described by the US government as inadvisable given current market uncertainty. This immediately led to an increase in oil prices. Despite the risks of inflation, it is economically sound for the producers to make such cuts. Ultimately, unlike in October 2022 when Biden threatened ‘consequences’ against Saudi Arabia for similar cuts, this time such strong criticism has yet to happen. Therefore, the statement from the US may be a chiding rather than anything of consequence. The OPEC+ move was inspired by several factors, and is likewise projected to have several effects.
Firstly, the cuts were aimed at increasing the price of oil. This immediately manifested with the price of a barrel of oil increasing by $5 to $85. Recently, there has been a drop in oil prices partially caused by the banking crisis in the USA and UK where investors sold commodities leading oil prices to drop to near $70 a barrel. In the 2008 crisis, oil prices dropped severely which likely drove producers to hedge against the risk of history repeating itself.
Secondly, the size of the cut may indicate OPEC’s fear of global recession. Since recession worries have been present in the years post-COVID, it is obvious that the world's oil consumption could be in jeopardy. As a result, oil producers took proactive measures in reducing production to raise prices. The size of the cut was justified by Russian minister, Alexander Novak, as aimed at market stability, with some commentators viewing this as implying a fear of US-based recession. Indeed, the cuts may also be a bet that stronger demand from China will offset any reduced demand in the west.
In addition to China’s ability to offset, there are geopolitical and economic ambitions that may lead OPEC+ members, especially Saudi Arabia, to raise prices by cutting oil production. Saudi Arabia is a leader within OPEC+ when setting prices for oil. For Crown Prince Mohammed bin Salman (MBS hereon), there is a need to pursue a strategy of non-alignment where Saudi Arabia can maintain its ties with the US and China by not succumbing to pressure from either. This is essential because the US is a strategic partner for arms, while China remains Saudi Arabia’s largest purchaser of oil. Recently, China has also played a role in regional politics such as through the recent détente between Iran and MBS.
Potential Effects
This cut resulted in higher oil prices, raised tensions with western countries and risks further inflationary pressures. Excessively high oil prices are likely to increase inflation especially for goods that Western countries are likely to need. Moreover, the Biden administration strongly opposed such an increase in oil prices and therefore, the persistence from Riyadh is unlikely to improve relations between the two states.
For the war in Ukraine, higher oil prices mean there will be money flowing to the Kremlin adding to their war chest and building Putin’s resilience in Ukraine. Moreover, the sudden nature of these oil cuts, which normally take weeks of discussion, further indicates a state of affairs dominated by nations focused on their own self interests. The resulting uncertainty around the actions OPEC+ can take relating to oil production could result in greater volatility that may compromise the health of a frailing global economy.
There are fears among some experts that we may be headed towards a 1970s style stagflation. This is unlikely for two main reasons. First, while oil prices have increased, these are likely to be contained through spare production capacity in other parts of the world as well as strategic reserves in Western countries. Second, and most importantly, the world has a lower reliance on oil today than it did in the 1970s. Therefore, an increase in prices, in the era of energy transition, may have a lower likelihood of resulting in stagflation.
Future Projections
Ultimately, there is a possibility that the spike in oil prices will be short-lived since it affects global demand forecasts at a time when the international economy is already under financial stress. While the cut was driven by decreased forecasts, there is a risk that oil demand will remain low when one considers the higher oil prices caused by the production cuts. OPEC+ may therefore be forced to consider reducing prices to drive up demand in the medium term.
It remains unclear what these cuts will mean for interest rates. In order to curb inflationary pressures arising from these production cuts, central banks may have to increase interest rates. Where the price of oil will be is another uncertainty. While initially heading up to $85 after the announcement, the strongest possibility is that reduced supply will drive this even further to around $100.
On a positive note, this production cut and related price increase may speed up the transition to renewable energy. Such a price rise would lead consumers to consider renewable and green energy options as an alternative to oil and oil products. In the aftermath of these oil cuts, the White House and EU affirmed the central importance of clean energy, its adoption, and use in ensuring global energy security. The EU has already banned the sale of diesel and petrol cars by 2035 in a further sign of their commitment to the energy transition. Regardless, these cuts are likely to have an ongoing economic impact globally and it remains to be seen how further action from OPEC+ will influence political relations with the US, China and Russia.