On Tuesday 5th September, Saudi Arabia announced that it would be maintaining its voluntary crude oil production cuts of 1 million barrels per day until the end of the year. Russia simultaneously announced it would be continuing its own cuts of 300,000 barrels per day for the same period. Markets reacted to the news as intended, with Brent prices rallying above the $90 mark for the first time this year. In this week’s article, we look at the key reasons behind this latest round of cuts and how it affects the oil market outlook for the rest of the year.
Saudi Arabia and Russia Pursue High Oil Prices
One of the driving forces behind Saudi Arabia's decision to extend production cuts is its desire to keep oil prices high. This aligns with the broader strategy of the OPEC nations throughout this year. As the largest and most influential member of OPEC, Saudi Arabia has the capability to significantly influence global oil markets. Rather than relying on the collective decisions of the group, Saudi Arabia has taken the lead in making these cuts. This consistent theme in OPEC's actions throughout the year underscores their commitment to supporting higher oil prices, which, in turn, boosts their GDP and strengthens their fiscal position.
For Russia, higher oil prices provide a way to mitigate the impact of international sanctions. Various sanctions have been imposed to reduce Russia's earnings from crude oil products, serving as retaliatory measures following its invasion of Ukraine. Most notably, buyers are not able to purchase Russian crude oil for a price above $60 per barrel if they wish to use Western shipping insurance, while similar mechanisms are in place for both heavier and lighter fuels. However, it has been widely reported that Russia has found ways to circumvent these sanctions by avoiding Western ships and insurance providers in order to continue selling crude oil above imposed limits.
BRICS and Geopolitical Power
An additional layer of complexity in the current geopolitical landscape is the recent invitations extended to several countries to join the BRICS group. BRICS, originally consisting of Brazil, Russia, India, China, and South Africa, has now invited six other countries to join its ranks including Iran, the United Arab Emirates (UAE), and Saudi Arabia.
With the addition of these nations to the group, BRICS will gain control over approximately 40% of global oil production. This would significantly bolster the political power of the group in the realm of energy geopolitics. It underscores the growing influence of these oil-producing nations on the global stage, potentially reshaping the dynamics of the energy market and international politics and undermining the hegemony of the US dollar as the world’s reserve currency.
Challenge for Central Banks?
The rising energy prices resulting from Saudi Arabia and Russia's production cuts pose a challenge for central banks worldwide. At a time when it appeared that inflation was gradually being tamed, this unexpected surge in oil prices has raised concerns.
Central banks, including the Federal Reserve and the European Central Bank, had signaled that they were nearing the end of their interest rate-increasing cycles. The Bank of England was expected to have one final rate hike. However, the resurgence in energy prices could disrupt these plans.
The impact of rising energy prices on inflation is complex and can vary depending on several factors. As energy prices surge heading into the northern hemisphere's winter, a period of peak demand, there is a risk that inflation may persist longer than anticipated by central banks. This potential inflationary pressure may force central banks to reevaluate their monetary policies and potentially extend their rate-increasing cycles.
Will prices rise further?
As noted by Clyde Russell for Reuters, there are currently “too many competing narratives and driving factors” for a consensus outlook on the future of oil prices. UBS published a note informing its clients that the bank expects Brent to average $95 in the final quarter of the year, which aligns with ChAI’s current Quarterly Price forecast for Q4 of $94. However, it is worth considering that it is only a month since China published a range of economic data which was widely considered to be bearish for markets. At present then, market participants will be watching closely for the next major news story to swing momentum in crude markets.