The economics of OPEC’s cut in oil output

It is not surprising that market experts are debating the announcement made by the Organisation of Oil Exporting Countries (OPEC) + on Sunday to cut oil production between May and end -2023 by about 1.16 million barrels per day (bpd), with Saudi Arabia alone accounting for 500,000 bpd, United Arab Emirates (UAE) by 144,000 bpd, Kuwait 28,000 bpd, Iraq 211,000 bpd, Oman 40,000 bpd, Algeria 48,000 bpd. “This voluntary initiative is a precautionary measure taken to ensure market balance,” said UAE Energy Minister Suhail bin Mohammed Al-Mazrouei. This is expected to push up per barrel price by $10.

The oil production cut goes against general demand made by Western countries to increase oil output in the wake of the Russian invasion of Ukraine last February as Western countries imposed sanctions against Russian oil and gas exports. It is believed that rising inflation in the European Union (EU) countries is partly due to the disruption in oil supplies from Russia, and the United States wanted the Gulf Arab states to step in and step up oil production. But the oil-producing countries did not oblige because they felt that there was not enough economic activity in the West and there were clear signs of recession contrary to expectation. Europe is facing the complex situation of inflation and near-recession known as stagflation. It would seem that the OPEC + have read the situation correctly, though Western leaders believe that the cut in oil output has come at an inappropriate time. According to commodities analyst Barne Schieldrop at SEB, “What we are witnessing is an adaptive and agile OPEC + which is able and which is willing to act ahead of the curve. The recent market turmoil where Brent Crude dropped to $70 a barrel probably gave OPEC + a bit of a scare.” But other experts believe that the cut in oil production would not push up oil prices greatly and they would remain in the $80-$90 range for the rest of the year.

The Western financial experts are shy of admitting that the economy in Europe and in America is not out of the woods, and the central banks are fighting hard to tame inflation. The continuous hike in interest rates over the last year have showed some positive signs but inflation remains still high for comfort. Western economies have not recovered from the disruptions caused by Covid-19 pandemic and partly by the war in Ukraine. But the woes of Western economies cannot be laid at the door of only these causes. There are inherent problems which are now coming to the surface.

For example, the protests in France against the new pension system which requires people to work till 64 shows that the governments are not in a position to sustain the pension payments. And the National Health Service (NHS) workers in Britain are fighting for higher wages because of the cost-of-living crisis. There are deep structural problems in these economies, and the governments seem helpless in tackling them.

There is enough oil supplies if the global economy were to function in the high growth orbit, and the relatively low oil prices would not be a matter of concern. But when the world economy is struggling to grow at a healthy rate, the demand for oil would be relatively less, and it makes sense to cut oil production to maintain the price balance. If the oil inventories were to grow and the prices remain low, the balance would be broken. Also, the oil consumption is shifting to the east, with China and India consuming more as their economies expand. China has grown to be the biggest oil consumer even as it buys oil from Russia as well as the Gulf Arab states. OPEC + now does not have to depend on the economic winds in the West.