On Sunday, the Organization of the Petroleum Exporting Countries and allies including Russia, a group known as OPEC+, held its ministerial meeting behind closed doors in Vienna. Following the meeting, the announcement came of further cuts to oil production from the key industry group.
Most notably was the decision taken by Saudi Arabia, the group’s leading producer and dominant voice, which pledged a voluntary cut of over 1 million barrels per day in July, with the potential to extend the policy. However, while some Saudi officials may have hoped that the announcement would lead to a crude oil price rally, the reality is that the market’s reaction has been rather muted. In this week’s article, we look at some of the reasons behind the latest production cuts and how this situation might unfold.
OPEC+ Cut
The decision from OPEC+ stems from frustration at the continual decline in oil prices since the peaks of May 2022, and while the extreme highs of Q2 last year were unlikely to be sustained, Brent prices have traded below $90 mark since November having spent the majority of the previous 11 months above it. For the constituent nations of the group, crude oil revenues are essential to national economic growth.
When a surprise production cut was announced in early April, prices leapt up to around $87 in the following days and it is likely that OPEC+ members were hoping for a similar reaction to their latest news. Indeed, the unprecedented procedure of preventing press from attending the meeting itself, coupled with Saudi Arabia's Energy Minister Abdulaziz bin Salman warning that oil short-sellers should “be careful” in the days ahead of the meeting, set the scene for a dramatic announcement and a subsequent market reaction. So far, however, this latter part has yet to occur.
The other outcomes from the OPEC+ meeting, which consisted of lowering the production targets for Russia, Nigeria and Angola and allowing the UAE to raise its target, have largely been reduced to footnotes this week. Furthermore, existing production cuts announced last year and in April, totalling 3.66 million barrels per day, and were due to run until the end of 2023 had their deadlines extended to the end of 2024. This latter point in particular, when taken alongside the voluntary cut made by Saudi Arabia for July and possibly longer, may yet cause the desired upward price movement for crude oil. However, given the rhetoric of the group ahead of the meeting, a production cut would have been expected by most market participants, so it would have taken a seismic reduction for oil prices to be immediately pushed back above the $85 mark.
Weak Demand from Industrial Downturn
The key reason for the lack of upwards movement in oil prices following the OPEC+ announcement is that the wider economic picture remains bearish for prices, regardless of OPEC’s wishes to the contrary. According to Reuters, the week ending June 2 saw U.S. gasoline inventories rise by about 2.4 million barrels and distillates inventories increase by about 4.5 million barrels. Given that this week should have been the beginning of the peak season of US demand, which traditionally runs from late May’s Memorial Day weekend to Labor Day in early September, the build in inventories is as surprising for oil speculators as it is bearish. This build in inventories can be partly traced to the worsening state of US manufacturing and freight, which as noted by John Kemp for Reuters, have both witnessed activity decline for seven consecutive months and thus weakened demand for distillate products.
Weakening industrial activity is not confined to the US, with several major economies currently plagued by the same decline. China’s exports in May were down 7.5% year-on-year, for example, while imports were 4.5% down as well. The decline in trade has been picked up as a bearish driver within the Freight model for several of ChAI’s commodities; the graph above shows ChAI’s models have interpreted the trade data as weakening prices on the one, three and six month forecasts for Iron Ore. While expectations were that the trade declines could have been even larger, such reductions are particularly bearish when considered against the fact that the nation’s busiest port, Shanghai, was closed during May last year due to pandemic restrictions, as noted by Reuters. Elsewhere, South Korea continues to record weakening export figures month-after-month, while German manufacturing contracted for its 7th month in a row.
Simply put, there are currently too many signs of fragility in global manufacturing for the oil market to rally. At the same time, prices are unlikely to sink below the $72 mark as that is the level at which the US has signalled it will start buying oil to refill the depleted Strategic Petroleum Reserve. For the time being though, OPEC+ will need more encouraging signs from the industrial sector in order to achieve their desired price levels, rather than production cuts alone.
