OPEC Decision To Cut Output May Lead To Supply Deficit In Oil Markets

By Irina Slav of OilPrice.com

Last week, OPEC+ said it would reduce its oil production target by 2 million barrels daily, with actual cuts of between 1 and 1.1 million bpd. The announcement pushed prices higher. By the end of the week, the resulting oil price rally had run out of steam, and prices were once again sliding on recession fears. And these fears might mask how the oil market tips into a shortage.

When the cartel said it would be cutting production, OPEC officials explained the reasons for the decision had to do with anticipating a drop in demand and saving spare production capacity for the eventuality of a sudden output outage such as one in Russia following the EU embargo entering into effect at the end of the year, for example.

The U.S. signaled it saw the move as a political one, amounting to a snub by Riyadh, which will be one of three OPEC members actually reducing production, and a declaration of siding with Russia.

The latter Riyadh already did six years ago when OPEC+ was born, so it shouldn’t have come as a surprise, but the snub appears to have come as a shock to Washington, prompting President Biden to threaten “consequences” of a yet unidentified nature.

While the White House ponders its options, some analysts have noted that the move of OPEC+ would tighten an already tight oil market. Recession worry seems to be reigning in oil markets right now, but the risk of an oil shortage is there, and none other than OPEC has been warning about it, most vocally Saudi Arabia in the face of its energy minister.

Meanwhile, there is more bad news: global oil inventories are in a decline that would be difficult to reverse. This is what Reuters’ John Kemp noted in a column this week, saying U.S. inventories have shed 480 million barrels in the past two years, to reach the lowest level for this time of the year since 2004.

The situation with fuel inventories is even more worrying, with U.S. distillate inventories down to the lowest since records began in 1982, and European distillate inventories at the lowest since 2002. Distillate inventories in Singapore are also at a multi-year low, shedding 9 million barrels over the past two years.

The fall in distillate inventories is perhaps even more concerning than the decline in crude stocks because distillates are used to make diesel fuel, and diesel fuel is used in the freight transport of goods, which is vital for every economy. A reserve depletion means price hikes, and price hikes mean good fuel for inflation.

Still, despite the precarious state of global oil and distillate inventories, Saudi Arabia just said this week that the decision to reduce output was a purely economic one. In an official response to U.S. accusations, the Saudi foreign ministry issued a statement that said:

“The Kingdom clarified through its continuous consultations with the U.S. administration that all economic analyses indicate that postponing the OPEC+ decision for a month, according to what has been suggested would have had negative economic consequences.”

Whatever the motives for the decision, it has been made, and those unhappy with it have few options at their disposal for punishing those that made it. Oil prices remain subdued, meanwhile, although analysts updated their fourth-quarter price forecasts after the OPEC+ decision.

Again, this is largely because the fear of recession has been fuelled by a stable flow of pessimistic forecasts, the latest coming from the IMF this week. Indeed, the immediate future of the global economy does not look good, and when the economic outlook is bad, so is the oil price outlook. Yet a shortage of oil could certainly change this, especially when it coincides with an oil embargo and a price cap.