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  1. Home
  2. / Investing

OPEC: To Cut or Not to Cut Production?

Oil market dynamics in 2023 are a far cry from what was seen in 2022.
By MALEEHA BENGALI
May 23, 2023 | 02:00 PM EDT

As the market debates whether or not we are about to enter into a recession, investors have already started positioning themselves as though the Fed is about to cut rates tomorrow. This is far from a done deal and the Fed has yet to blink, but we know the bar for them to cut rates is very high. They cannot afford to make the same mistakes as they made in 2018 and 2019 when they flip flopped, their credibility is at stake here, especially as they got the entire inflation narrative wrong all of last year.

OPEC has its own dilemma right now as prices are making new lows and speculators going short once again. It quotes price stability and smoother functionality as reasons to cut, but it really is about maintaining a certain price level. That caused them to blink back in April as they wanted to "teach the shorts a lesson" and announced a cut of 1.6 mbpd starting from May.

This caused the oil price to rally all the way to $86/bbl., only to see prices back down to around $75/bbl., giving up all those gains and now trending lower. The shorts did get burnt in April after this surprise announcement. The cut was to include Russia's 500k bpd production decline, which have still not materialized.

This strategy tends to work in demand driven and tight markets as OPEC is one of the largest swing producers of oil along with the US and Russia. After the Russian invasion of Ukraine prices spiked to $135/bbl., but since then have come back down one way to $75/bbl. The oil market is not in short supply as such, it all depends on what demand you assume. After the Covid induced demand surge, the supply side was caught off side. But it is a matter of time as eventually demand does correct and play catch up to supply. That is economics 101.

But OPEC does not like to see economic cycles as they have too much at stake here. They were slow to bring back all the 10 mbpd of oil cuts back in 2020 over a period of two years, and don't mind the speculative longs on the way up, but do not appreciate the ones on the way down.

At the start of this year, all bullish hopes were pinned on the Chinese demand recovery post their reopening. Chinese demand recovery was a false start and most investors have their hopes pinned on a 2H Chinese demand recovery. IEA estimates of a 2.5 mbpd demand pick up in Q3/Q4'23 this year are just back end loaded, without any data to suggest the case.

We are facing a slowdown that is evident in all markets, and no commodity is being spared. If OPEC focuses too much on short term prices, then it can cause a price spike in oil which will put the global economy into recession for years. The best course of action is to let prices move to their natural equilibrium as the economy undergoes a slowdown, no matter how painful it is to see the price decline.

Central banks changed the landscape of investing when they introduced the notion of QE over the past decade and a half. The world has been awash with liquidity which took all asset classes higher... the everything bubble. When that liquidity comes out, no asset class is spared. One can try and control the price, but it all depends how much slack you have in the system, and oil market dynamics in 2023 are a far cry from what was seen in 2022.

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At the time of publication, Maleeha Bengali had no position in the securities mentioned.

TAGS: Commodities | Economy | Investing | Markets | Oil | Stocks | Trading | Energy | China | Russia |

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