OPEC’s Oil Output Cut Could Fuel Further Inflation

April 20, 2023

Over the past several weeks, oil prices went south, touching $70 a barrel around March 20, before a rebound following OPEC’s decision to cut production1 early in April on top of the already agreed 2 million bpd cuts already agreed upon by member nations for 2023. The downward spiral, which resulted in crude oil prices touching its lowest in 15 months, was attributed to the global banking crisis and its adverse impact on demand. Rising interest rates and the economic slowdown in the US, the top oil consumer in the world, meant that demand for oil was already low and OPEC’s intervention, though surprising in its timing, wasn’t altogether unexpected.

This response immediately triggered a revival with crude oil prices rebounding to $86 dollars to the barrel in the week of April 17. However, prices began going southward once again and are moving now in a narrow band of $77 and $79. With weak US economic data and weaker-than-expected corporate earnings from the tech sector casting its own shadow on future growth, sentiments around the commodity markets have been cautious. In fact, analysts believe that stabilization of the US dollar and spiking bond yields could further pressure these markets, more so as the Fed could well be considering yet another rate hike in May to tackle inflation.

The tightening supply

It is quite obvious that Saudi Arabia, OPEC’s top producer, is keen to keep prices high, at least at the current levels while hoping that the demand surges in line with predictions by the International Energy Association. The energy watchdog had predicted demand2 soaring to a record 101.9 million barrels a day this year, up by two million bpd last year. In fact, Saudi Arabia is apparently ready to cut its own output by 500,000 bpd as a precautionary measure to support market stability, a move that was termed “inadvisable” by the United States. The US has noted that the world needs lower oil prices to support economic growth and prevent Russia from earning more through its oil exports and using these revenues to fund the Ukraine war. It is quite obvious that OPEC+, of which Russia is a member, wants prices to hold around $70 a barrel and each time it slips, there could be a cut in the production. With the US shale output nowhere near the predicted levels, demand is more than likely to be strong through the year.

The Chinese rebound

While speaking of demand, China’s continuous opening up following three debilitating years of Covid-led under-performance is something that the oil industry would be watching closely. Positive economic data3 has started trickling in with the manufacturing and services industry on the upswing. Being the world’s largest crude importer, China could expect to enhance production in tandem with US demand for capital goods. Currently, the cheap Russian oil is what is working for the country – and to some extent India – but it is highly unlikely that Russia could actually divert all its Europe-bound oil to these countries as a result of sanctions.

Russian oil exports and its impact on the war

Which brings us to the Russia-Ukraine conflict itself. Shipping data from Refinitiv suggests that oil loading programs had slowed down in February with loading departures amounting to 2.3 MMbbl/day compared to 4.8 MMbbl/d in January. However, come March and Russia’s oil exports rose to its highest levels since April 2020 due to an increase in supplies. Export revenues touched $12.7 billion, up by a billion dollars while its supplies by sea grew by 0.6 million barrels a day to 8.1 million barrels a day. Given this continuous demand from China, India and now from more countries in the Far East, it appears as though sanctions from the West aren’t making much of a difference to Russia – at least not for the moment. The longer the war with Ukraine continues, the more Russia could potentially skewer global oil supplies.

Hardening oil prices fuels inflation

The OPEC+ couldn’t have come at a more inopportune time for North America and Europe as they battled to reduce inflationary pressures. In spite of the reducing influence of OPEC, higher oil prices make everything expensive – from production to transportation. Central banks were expecting inflation to cool off on grounds that there would be no spike in energy costs of the kind that was triggered by Russia’s invasion. However, the OPEC+ move would definitely result in a rethink at the Fed as their next meeting to fix interest rates comes nearer. It remains to be seen whether the Fed sticks with its earlier resolve of holding on to another 25 basis point rise to cool off the banking crisis or if the oil cartel’s move to fix a bottom to prices will make them push for another round of rate hikes in quick succession. Either way, it appears that the current high interest rate regime could last a while longer.

End Notes
1. https://www.reuters.com/business/energy/sarabia-other-opec-producers-announce-voluntary-oil-output-cuts-2023-04-02/
2. https://www.iea.org/reports/oil-market-report-april-2023
3. https://edition.cnn.com/2023/04/17/economy/china-gdp-q1-2023-intl-hnk/index.html