On Wednesday 5th October, OPEC+, at its 45th Joint Ministerial Monitoring Committee meeting held in Vienna, agreed to cut daily oil production by 2 million barrels per day. As it was the first in-person ministerial meeting for OPEC+ since March 2020, which itself signaled that a major announcement was looming, it was fitting that the group announced the biggest oil production cut since the start of the Covid pandemic. The size of the cut, equivalent to around 2% of global daily oil production, was significantly larger than the expected figure of 1 million bpd. However, according to Reuters, as several OPEC+ member states fell short of their target production levels in August, the real cut is estimated to be less than 1 million barrels per day. Given the magnitude of this step, it is worth looking into the role the group plays in the global oil market and how this latest production cut might affect prices.
OPEC’s Role
The Organization of the Petroleum Exporting Countries, or OPEC, was founded in 1960 and consists of 13 members which account for around 82% of global oil reserves and 30% of oil production. While neither the US nor Russia is part of the group, the latter is part of OPEC+, a wider association that includes 10 non-OPEC countries with shared interests in the oil market. The group, unofficially led by Saudi Arabia, sets production targets for its member countries which influence the global supply of oil, although its targets are not always met by all members. While there are other influencing factors on both the supply and demand side, OPEC+ does exercise a significant influence on the supply and therefore the price of crude oil.
OPEC has been accused on many occasions of behaving like a cartel, unnecessarily restricting supply in order to maintain high revenues from oil exports. The group denies this; OPEC’s secretary general Mohammad Barkindo stated earlier this year that the organisation had “no control” over the spike in oil prices following Russia’s invasion of Ukraine. However, it remains true that due to the proportional significance of oil revenues to OPEC members’ economies, the group certainly benefits from high oil prices.
Incentives to Intervene
In the past few months, there has been notable price volatility in the oil market, though the overall trend has been bearish since the Q2 peak of $123.58 per barrel on June 8th as shown in the graph above. In the past 10 days, oil prices have been hovering between $84 and $90 per barrel and the threat of oil’s value slipping even further is a key reason behind the decision taken by OPEC+.
A second reason behind the cut is the need to improve the spare capacity of some of the key oil producing nations, particularly Saudi Arabia. With the looming threat of a US-led price cap being imposed on Russian oil exports, the expectation is that supply may become even tighter, at which point Saudi Arabia would then increase production once again to take advantage of higher prices. In cutting production ahead of any price cap being introduced on Russian oil, OPEC+ is also sending a strong message to the US that buyers will not dictate oil prices.
Russia also has much to gain from higher oil prices. Due to the sanctions imposed on the nation following its invasion of Ukraine, the buying market into which Russia can sell its oil has been reduced to a few remaining participants. Furthermore, Russia and Saudi Arabia arguably have more to gain from high oil prices than anywhere else; the nations are the third and second largest producers of oil, only behind the US, yet their energy revenues are more proportionally more significant than in the diversified economy of the United States.
The movement towards an alliance between Riyadh and Moscow will frustrate the United States. Earlier this year, President Biden travelled to Saudi Arabia ostensibly to negotiate commitments to greater oil production from the nation. The trip was particularly significant given Biden’s criticism of Crown Prince Mohammed bin Salman, in relation to his alleged connection to the murder of journalist Jamal Khashoggi. This latest announcement from OPEC+ casts Biden’s trip to Riyadh in an unfavourable light, and adds pressure to his administration in the run-up to the nation’s midterm elections in November.
Record Refinery Margins
While the oil market headlines will initially be dominated by OPEC+ announcements, another part of the industry that will come under examination in the coming months is the refinery sector. Refinery utilisation rates have been unusually strong this year and, as noted by Reuters, could remain above 90% in the US for a third consecutive quarter in Q4 2022. The US has particularly maximised its refinery capacity due to pressure on the industry from the Biden administration to lower domestic gasoil and diesel prices as the midterms loom.
Elsewhere in the world, refineries have also been run at high levels for two reasons. The first is due to the capacity that was lost as plants were forced to close during the Covid pandemic, meaning there is now a lesser total amount of global crude oil refining capacity. The second, more significant, reason is that margins for refiners have ballooned to record levels this year. This issue was explained by Erwin Seba for Reuters: “the margin from selling diesel from a barrel of oil and replacing that barrel, called the diesel crack spread, this week [26/09/22 – 02/10/22] was about $54 per barrel on the Gulf Coast, compared to about $12 a year ago, according to Refinitiv.” This level of profiteering within the refinery industry may come under closer inspection if global oil prices rally back north of the $100 per barrel mark.
Back in August, Saudi Arabian Energy Minister Prince Abdulaziz bin Salman cited “extreme” volatility as a key reason why OPEC might need to step in and protect the integrity of the oil market. Wednesday’s announcement of a production cut of 2 million barrels per day is unlikely to instantly relieve the oil market of the price volatility seen during 2022, but it may alter the wider trajectory of oil prices to point higher once again. It remains to be seen whether the Energy Minister will remain as concerned about market volatility if prices rise above $100.
By ChAI Predict
