Opec+ unleashes shockwaves with major cuts in oil production

Deep oil production cuts approved by Opec+ sent shockwaves through energy markets, putting the cartel on a collision course with Washington and hinting at a strengthening of Saudi Arabia-Russia ties.

The Opec cartel and allied producers agreed on Wednesday to collectively cut production by 2 million barrels a day. The move threatens further inflationary pressures in a global economy already weighed down by an energy crisis.

The implications are far-reaching, from future oil prices to future US-Saudi Arabia relations.

What Opec+ has agreed to – and why

The group, led by Saudi Arabia and Russia, cut its collective oil production target by 2 million barrels a day, or about 2 percent of global consumption. The actual supply cut will be smaller – likely closer to 1mn barrels – as many smaller members like Nigeria are already producing below their targets.

Still, the move is an aggressive attempt to raise oil prices. At $90 a barrel, crude oil is well below levels reached just after the Russian invasion of Ukraine, but higher than at any point between 2015 and early 2022. The pain of higher oil prices is compounded by the stronger dollar for many countries increased who have to buy their oil in US currency. Petrol prices in the UK are above 2008 levels when oil prices hit a record high of almost $150 a barrel, fueling inflation and a cost of living crisis.

UAE energy minister Suhail Al Mazrouei said OPEC+ was being cut to avert a price slump like the one seen in the second half of 2008 when oil prices plummeted to $30 a barrel during the financial crisis.

“We need to forestall an oil market crash due to the slowdown,” Mazrouei told the FT, arguing that without action, long-term investment in the industry would suffer.

Saudi Arabia’s Energy Minister, Prince Abdulaziz bin Salman, has indicated that they do not want to repeat recent mistakes by central banks, which he says have made a mistake by not responding quickly enough to inflation.

But high energy prices themselves are a major driver of economic pessimism. The most damaging price rise was caused by Russia, as it cut gas supplies to Europe in a bid to weaken Western support for Ukraine.

The Gulf cartel’s oil producers have been irritated by the US’ continued release of crude oil from their emergency stockpiles. Washington has also spearheaded efforts to impose a price cap on oil exported by Russia. If the plan works, Gulf producers fear the price cap could push prices of their own oil down — or one day be extended to them.

setback in Washington

The White House accused Opec+ of aligning itself with Russia and harming the global economy. Jake Sullivan, President Joe Biden’s national security adviser, and Brian Deese, chief economic adviser, pointed to possible reactions, including more releases from the national strategic petroleum reserve – a possibility the White House dismissed just a day ago. “Responsible action” to increase domestic energy production was also on the table.

The Biden administration also vowed to consult with Congress on ways to “reduce Opec’s control over energy prices.” The announcement proposed relaunching so-called “Nopec” legislation, which would crack down on oil cartels by allowing the Justice Department to sue countries for anti-competitive behavior.

RBC Capital Markets’ Helima Croft said that in addition to Nopec’s “dog whistle” hint, she believed the “clearer risk” was that the US would restrict exports of refined products like gasoline to avoid fuel price inflation impede .

The stormy reaction reflected deep disappointment in Washington, whose diplomats have worked hard in recent days to stop the cartel from announcing fresh cuts. Biden traveled to Saudi Arabia in July to improve ties with Riyadh ahead of the US midterm elections.

Why tensions between Saudi Arabia and the US have grown

Sullivan and Deese did not question US strategic and defense ties with Saudi Arabia. But the split between Riyadh and Washington points to a broader dissolution of their decades-old energy alliance.

Biden called Saudi Arabia a “pariah” during his campaign in response to the killing of journalist Jamal Khashoggi. Crown Prince Mohammed bin Salman has said he “doesn’t care” if the US President misunderstood him. The two leaders’ carefully choreographed meeting in the kingdom this summer made it clear that there was little affection between them. Months of Petro diplomacy to improve ties, with White House officials repeatedly shuttling to Saudi Arabia – including in the run-up to this week’s Opec+ meeting – now appear to have hit a wall.

Saudi Arabia is also understood to be angered by what it sees as a lukewarm US commitment to the kingdom’s security, including the limited US response to the attack on its critical Abqaiq oil facility in 2019, by which widely believed to have been carried out by Iran.

The kingdom has tried to diversify alliances from China to Russia, with the former now a far larger buyer of its crude than the US.

However, the US still has significant influence as the Kingdom’s largest supplier of military equipment.

Effects on the oil market

The price of Brent crude reached $93.96 a barrel after OPEC+ announced its cut, up from $84 a barrel last week. Jorge León, a former Opec analyst who now works at consultancy Rystad, expects oil prices to top $100 by Christmas.

Further gains are possible as European sanctions on Russian oil sales are tightened in December. Moscow has also warned it could cut oil exports to countries participating in the US price cap plan. Opec’s new production cuts, due to begin in November, could therefore coincide with further supply cuts.

Years of underinvestment across the industry mean that supply is still constrained and global spare production capacity is “extremely low,” the head of state-backed oil company Saudi Aramco warned this week.

While the production cuts will put “upward pressure” on prices, JPMorgan’s Christyan Malek said Opec+ intervention to keep oil prices high is intended to encourage all producers to start investing.

“The sheer size of the cut sends an important message to the industry,” he said.

What’s next for Opec+

Prince Abdulaziz, Prince Mohammed’s older half-brother, has set the kingdom on a more confident course on oil policy.

People briefed on Saudi Arabia’s mindset believe Prince Abdulaziz is being pressured by his half-brother, the country’s day-to-day ruler, to secure an oil price of around $100 a barrel to fund ambitious reform programs.

The kingdom and its Gulf allies are unlikely to turn their backs on Russia. The Gulf states have not opposed the invasion of Ukraine, and bringing Russia closer to Opec has been a long-term goal. Saudi Arabia and Russia are the two largest oil producers in the world after the United States.

Asked about Russia’s role in the energy crisis and whether it made their partnership more difficult, Mazrouei from the United Arab Emirates said they did not want to take sides.

“In Europe they have their own history, in Russia they have their own history. We cannot side with this country or that country,” Mazrouei said.