As Brent oil broke below $85/bbl. last week preceding the famous JMMC and OPEC+ meeting, rumors circulated of a potential cut to provide stability in the markets. Low and behold prices rallied into the meeting that on Wednesday confirmed a 2 mbpd cut in production.
Stability was quoted as justification for the move. It is a wonder when stability is always mentioned when prices fall but not when prices rise aggressively to the upside. Brent oil is down from $135/bbl. at the onset of the Ukraine war but is now down to $85/bbl., and this is worrying OPEC members even though Brent today is trading above pre-Covid levels, so one wonders, what is the reason for OPEC+ hasty decision to cut now especially at a time when the world is battling with inflation?
What do they know or afraid of to make the announce they did this past week allowing Brent prices to rise $10/bbl. trading close to $96.5/bbl. today?
First, it is important to put the OPEC+ cuts into perspective. The group has been overproducing for the past few months whereby Saudi and UAE have been producing way beyond their quotas at the expense of some that could not achieve their quotas. This cut is more about optics than anything else. The actual cut amounts to about 600-800k bpd with most of it being felt by Saudi and UAE bringing them back into line.
There is a lot of press debating whether this was a move to keep their partner Russia happy. This has been denied by Saudi Minister but nonetheless it is important to know that Saudi and the region themselves need $90/bbl. plus oil to justify their deficit spending plans for the future. They cannot afford an oil price collapse, there is too much resting on it. But it would seem a bit pre-emptive to cut now especially when prices have only mildly corrected from pre-Covid or pre-war times.
The world is battling with heightened inflation and the Fed has no choice but to keep raising rates till that inflation comes down. Demand collapse is the only way to get prices back under control. The Fed is taking a longer term look rather than OPEC+ that is trying to maximize short term profit. Also, the winter has not started yet, so if we get a cold snap, it would make matters much worse, and for consumers of course. In hindsight, letting prices adjust in the near term would mean better and more sticky prices long term when demand does return, but that requires patience.
Bringing production in line with quotas can help to ease the physical and financial market disconnect. But it is a bit more complicated than that as financial instruments they are forward looking and impacted by speculative and macro activity. Given the surge in central bank liquidity, this too has impacted oil markets, but of course the producers never question it on the way up, only panic on the way down.
This is all too similar to 2008 when prices rallied on supposed tightening. It was not until the entire system collapsed that took prices down as demand collapsed. We can all predict the supply, but it is demand that is the hard one to do so. Prices always fall first until it is reflected in the data, but then it will be too late.
Since Covid, governments and policies seem short term in nature as policy markers try to tackle problems with immediate solutions rather than long term planning. The same can be said in the gas and electricity markets. Time shall tell if OPEC+ decisions proved to be wise or a rash decision. As the old adage goes, "don't trade your PNLl", it never ends well.