OPEC+ Decision on Production Cut to Tighten Market Further: Emirates NBD

The decision by OPEC+ to cut production by 2mn barrels per day (bpd) from its August baseline levels will tighten the market further, according to Emirates NBD. OPEC+ does have some merit in trying to anticipate a period of slower growth in oil demand, the regional banking group said in a report.

“Risks to oil demand growth are skewed to the negative as economies respond to substantially tighter monetary policy, high inflation, and slower economic activity. While a total collapse like the market endured in 2020 is highly unlikely, a considerable slowdown in the pace of demand growth looks set for next year, though total demand probably won’t shrink,” noted Edward Bell, senior director (Market Economics) at Emirates NBD.

However, he said, there is a risk of demand outperforming should China adjust its zero-Covid strategy and activity bounce back sharply from its current doldrums. Cutting production also worsens an already fraught supply picture. OPEC+ has been missing targets in aggregate thanks to underperformance by several members, Russia faces a shrinking list of destinations for its exports thanks to sanctions, and investment outside of the OPEC+ grouping has been lagging, keeping production from countries like the US at an effective standstill.

At the same time, global inventories have been drained as governments responded to high oil prices by releasing strategic reserves: Total US crude oil inventories have plummeted as Strategic Petroleum Reserve (SPR) stocks have been released. By sticking to August baseline levels, the 2mn bpd targeted cuts will be watered down considerably. Of the 19 members of OPEC+ that have been participating in production targets (Mexico is included but has not participated), Emirates NBD estimates only seven will actually need to cut production from November onward if using August targets as their baseline.

Most members of OPEC+ currently have production targets higher than their recent output so will not need to cut. All of the actual cuts will come from producers in the Middle East and Africa with Saudi Arabia, the UAE, Kuwait and Iraq required to make the largest adjustments to hit their target level. Market response to the cuts was relatively mild given that they had been expected and the headline cut was immediately neutralized by sticking to old baselines that don’t reflect existing oil market realities, the report noted.

Brent futures have bounced by about 11% since hitting a recent low of US$84/b, pushing back up above US$90/b, while WTI has also recovered, moving further away from the high US$70s handle it had hit recently and closing in on US$90/b in response to the OPEC+ decision. “We had outlined previously how markets face a strained supply picture and that oil prices will likely push higher going into 2023 and are holding to that view for now,” Emirates NBD noted.

Importing nations may choose to respond by releasing more of their strategic reserves with the US administration responding to the cuts immediately by saying they were “disappointed by the shortsighted” decision and that the president will continue to “direct SPR releases as appropriate.” However, further legislative responses — the oft threatened No Oil Producing and Exporting Cartels Act (NOPEC bill) in the US for instance — are unlikely to be effective in prompting more oil from the OPEC+ alliance. Draining inventories more may actually keep the market even more anxious and prompt an even bigger bid under near-term oil, steeping out the backwardation in markets, the report noted.