In a surprise decision, OPEC+ announced a 2 million b/d supply cut in November, exceeding the market expectation of a 1 million b/d cut. However, a supply cut of 2.0 million b/d will translate to only 1.08 million b/d coming mainly from Saudi Arabia (520,000 b/d), Iraq (140,000 b/d), the UAE (185,000 b/d) and Kuwait (120,000 b/d). Further cuts will come from Algeria, Gabon, Oman, and Brunei totaling an additional 115,000 b/d. The remaining OPEC+ countries, including Russia, will not see a change in production as the new quotas are still higher than their current production levels. This agreement is explicitly for November but could extend beyond November. The broader declaration of cooperation that was set to expire in December was extended through the end of 2023.
OPEC operates one month in advance and tries to preempt the market. The risk of regional recessions is rising and key Asian markets that are essential for Arab Gulf producers are showing signs of weakness. Although we expect a fairly hefty increase in Chinese crude demand in 2023, the concern about Asian oil demand is more short term.
Spare crude oil productive capacity is also an issue. With little left even among the largest producers, OPEC risks the inability to deal with future shortages if they were to arise. But given the assumption of recession, which should lower oil demand, concern about spare capacity seems to be a little bit of window dressing for the deal. OPEC is essentially using the opportunity to marginally recalibrate the quotas and record just a bit more spare capacity.
The member countries also seem to think they need to prop up the price, but the ban on Russian imports to the EU will likely do that anyway. The question that arises now is what happens in December when Russian supplies are at risk. Do the Gulf countries reverse course and provide volumes to Europe?
Relations with the U.S. and Europe
The US has a few ways to offset this supply cut. First would be an extension of the SPR release or delay the “payback” of crude to the SPR. Additionally, the US can continue easing sanctions on Venezuela, which could bring production and exports up by about 250 to 400,000 b/d.
This step, led by Saudi Arabia, does not bode well for US-Saudi relations. Saudi Arabia, regardless of the market language this agreement is cloaked in, has effectively elevated its partnership with Russia and signaled its willingness to damage its relationship with the US to preserve it. The shift of Russian crude oil to Asia positions Russia as a competitor to Saudi Arabia and the Gulf states over market share. However, this competition is overstated when considering that the Arab Gulf states cover 75 percent of the Chinese crude import market. In the meantime, an opportunity to lift sales to Europe will present itself in the months ahead. European refiners will likely welcome replacement barrels, but this agreement will not endear the Gulf producers to energy starved Europe.
This agreement is moderately bullish for prices since the market is indeed in surplus today. Next month’s decision on OPEC+ production in December will determine if it becomes a more substantially bullish development for the winter.