OPEC to protect downside on oil prices

OPEC+ has agreed to cut production targets in October by 100k b/d across the producers’ alliance, effectively unwinding the planned increase for September. To justify the output cut, OPEC+ highlighted how “volatility and the decline in liquidity” were impacting oil markets and pledged a “readiness to make immediate adjustments to production in different forms.”

The overall cut to output is negligible and is hardly going to be noticed in oil markets and at a country-by-country level the changes in targets will be minimal. For the UAE, for instance, total output will fall by just 10k b/d compared with September target levels. However, a lower target is more likely to be achieved given OPEC+ has been failing to hit production quotas for much of this year, mainly as a result of disruptions to Russian production stemming from the country’s invasion of Ukraine but also as a result of underinvestment and capacity constraints in many other producers. The IEA estimates collective OPEC+ over-compliance with its July target at 533% as only Saudi Arabia and Kuwait came within 10% of hitting their quota levels.

Rather than making a noticeable dent in oil market balances, the plan for an October cut shows OPEC+’s readiness to intervene to protect the downside in oil prices, as spot futures have fallen considerably since the end of June. Should prices continue to edge lower into the end of Q3 or into the final months of the year, we would expect OPEC+ to approve more meaningful production cuts, say 500k b/d to 1m b/d, to prevent any disorderly sell-off.

With Russian oil production likely to be further curtailed from December once EU-sanctions on seaborne imports come into effect and as inventories globally have been drained—both because of strong demand in Q1 and as a result of strategic reserves being released—a more proactive OPEC+ will help to set a floor under prices and increase the probability of upside shocks going forward. There are few buffers in oil markets at the moment that can accommodate an unanticipated supply outage because of a hurricane or political unrest—witness recent events in Libya and Iraq for example. The one relief for consumers remains China’s low levels of economic activity thanks to the country’s zero-Covid policy; should pandemic restrictions there ease, as appears to be expected by the end of the year, the risks for upside in oil continue to accumulate.