With surprise output cut, OPEC eyes price, global market stability amid banking crisis fears

Decision to reduce oil supply triggered by potential banking crisis may have economic, geographical consequences

Muhammed Enes Calli  | 06.04.2023 - Update : 11.04.2023
With surprise output cut, OPEC eyes price, global market stability amid banking crisis fears


OPEC+ countries announced a surprise cut Sunday in oil production by about 1.6 million barrels per day (bpd), a significant reduction that could pose a new risk to the global economy.

Saudi Arabia led the way with 500,000 bpd of cuts followed by Iraq with 211,000 bpd, the United Arab Emirates with 144,000 bpd, Kuwait with 128,000 bpd, Kazakhstan with 78,000 bpd, Algeria with 48,000 bpd, and Oman with 40,000 bpd.

The International Energy Agency (IEA) also on Monday said that the latest OPEC cuts risk straining the tight oil market by pushing prices up during a period of strong inflationary pressures as well as hurting vulnerable consumers worldwide.

The decision to cut oil production came two weeks after prices declined to 15-month lows over the fallout from the banking sector.

Despite pressure from the US and other countries to pump more oil into the world economy, there are several motivations behind the decision by OPEC+ producers to cut output levels.

"The OPEC+ cuts announced on Sunday are a reflection of the group's more pessimistic macroeconomic outlook at a time when oil markets had become oversupplied," Colby Connelly, a research analyst at Energy Intelligence, told Anadolu.

"We had expected oil supply to tighten closer to the summer, with demand in China and the US supporting higher prices closer to that time of year. However, the fallout from the banking sector took oil below $80/bbl (barrel) in March, which major OPEC+ producers are very likely to be interested in defending as a price floor," he said.

Mamdouh Salameh, a visiting professor of energy economics at ESCP Europe Business School in London, said the move could also be interpreted as "belated support" to Russia over the Western oil price cap against Russian crude oil exports.

"Moreover, OPEC+ members except Russia need a Brent crude price of $80-$100 a barrel to balance their budgets."

Russia said that it would extend its existing 500,000 bpd of output cuts until the end of 2023.

Asked if he had anticipated the move, Salameh said it was indeed unexpected, adding that OPEC+ has been "watching the market closely" since the US Silicon Valley Bank (SVB) collapse which was followed by a plunge in the stocks of Swiss banks UBS and Credit Suisse.

"While fears about a banking crisis have eased considerably, they haven’t disappeared completely, hence OPEC+’s decision."

However, Connelly added that as "OPEC+ had originally announced a production strategy that would run to the end of 2023, the decision to react to market conditions isn’t a major surprise."

"The fact that this announcement came in advance of an (OPEC+) Joint Ministerial Monitoring Committee (JMMC) instead of after it is one major reason a lot of analysts were caught off guard.”

He added that the move mostly happened "sooner" than anyone "expected" it would.

"But OPEC and OPEC+ are historically no strangers to plot twists, and in that respect, this outcome could almost be described as business as usual."

Stewart Glickman, an energy equity analyst at CFRA Research, spoke of what happened to oil prices in 2008 and 2009.

"In July 2008, WTI crude broke above $145 per barrel. By February 2009, it was below $35 per barrel. No one with a stake in oil production wants to see that scenario again," he told Anadolu in an interview.

Oil prices will likely be higher on average for 2023

On the possible consequences of this move, Connelly underlined the probability that oil prices will be higher on average for 2023, but that is strongly dependent on the macroeconomic situation and the response of OPEC+ if the oil markets overheat towards the middle of the year.

"It could be just as likely that OPEC+ tapers some of these cuts if the market really heats up into the summer, but that outcome is far from certain at this stage."

Salameh highlighted the potential geopolitical consequences of the unexpected oil production cut as the US will not be able to refill its Strategic Petroleum Reserve (SPR) for two reasons.

"One is that US shale oil which would have been a source for refilling the SPR is a spent force incapable of raising production meaningfully. The second is that the OPEC+ cut will make the global oil market tighter with no spare oil to help refill the SPR."

'This will not help US-Saudi relations'

US Treasury Secretary Janet Yelled called the agreement to cut oil production an “unconstructive act” which could damage the US fight against inflation.

"I think it’s a regrettable action that OPEC decided to take. I’m not sure yet just what the price impact will be, I think we need to wait a little longer for, you know, to really assess that," said Yellen.

Connelly said he believes the move will not help US-Saudi relations.

"But it is also unlikely to cause as many issues as the October 2022 OPEC+ cut, with a major factor being that the US midterm elections aren’t about to take place as they were during the last announcement," he added, referring to US congressional elections held two years after a president is elected.

He also said the administration of President Joe Biden, a Democrat, may have more trouble with the decision than would a president from the Republican Party.

"Longer-term, the impact of OPEC+ decisions on US-Saudi ties are more likely to be a function of where the market stands, but from a domestic perspective this issue is tougher for a Democrat to deal with than a Republican, so it may be less likely that there is a rift over OPEC+ production under a Republican administration. In that regard, more bipartisan views are likely to negatively impact the relationship, such as Riyadh’s growing ties with China."

Saudi Arabia, Iran, and China on March 10 announced a Chinese-brokered deal over reestablishing diplomatic relations between Riyadh and Tehran.

Salameh said that Saudi Arabia and other OPEC+ countries can respond to US opposition to the cut by withdrawing all of their investments and bank funds from the US and also replacing the petrodollar with the petro-yuan.

According to Glickman, Saudi Arabia is "prioritizing its economic self-interest" more than it prioritizes "good diplomatic relations."

"Biden has already drawn down the SPR (which is supposed to be for emergencies) to about 55% of capacity in a short period, which he did when oil broke above $110 per barrel. It has not yet been refilled."

"It would be difficult for him to encourage more domestic production when he is already on record as saying that we need to prepare for the energy transition away from fossil fuels," he added.

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