Last week, OPEC+ agreed to a 2 million bpd cut in production quotas for the months of November and December. This cut is slightly larger than what producers discussed leading up to the meeting. The decision had an immediate impact on oil prices, but there are also important market, policy, and geopolitical implications for oil prices that traders should keep in mind over the coming months.
What the initial market reaction shows
Oil prices reacted sharply to last Wednesday's news, and by the end of last week, both the WTI and Brent benchmarks showed strong gains. WTI rose from $80 per barrel to almost $93 per barrel and Brent went from $85 per barrel to nearly $98 per barrel. However, the market was unable to hold these gains early this week, as traders remembered that a global recession may be imminent and that rising COVID cases in China could cut oil demand there more than expected. WTI fell to $87 per barrel and Brent dropped to $92 per barrel a the close of markets on Wednesday.
This type of market reaction this week indicates that OPEC+'s concerns of weakening global demand are not unfounded.
How OPEC+'s move will impact the physical market
As I discussed in last week's column, many OPEC+ producers are not producing at their assigned quotas, so many will not have to cut production much at all. The deal did not include any extra cuts from producers like Saudi Arabia, the UAE, and Iraq that are producing at or near their quotas. This means that the actual number of barrels that should come off the market starting in November will be significantly less than 2 million bpd. Saudi oil minister Abdulaziz bin Salman believes that the actual production cut will be between 1 million and 1.1 million bpd of oil.
However, this depends on whether producers adhere to their commitments. Already, it seems that Iraq will not cut its production by the full amount. According to a report in the Wall Street Journal, Iraqi politicians are already voicing their concerns about the cut. The top candidate to become Iraq's next Prime Minister has said publicly that Iraq cannot afford to cut oil production and that he intends to ask OPEC to "reconsider the share of Iraq" in OPEC's total output cap. According to the report, this sentiment is shared by other Iraqi officials. According to S&P Global, Iraq produced 4.5 million bpd in September, which was just under its 4.66 million bpd quota. It would have to cut production by 220,000 bpd starting in November. In the past, Iraq has often overproduced its quotas. It is likely that Iraq will make some effort to cut production but will not cut nearly as much as its quota calls for. Traders should consider that compliance probably won’t be perfect when looking at the physical market for the rest of 2022.
How the U.S. reaction to OPEC+'s decision could impact the market
U.S. policymakers reportedly pressured Saudi Arabia and other Middle-Eastern producers to refrain from cutting production quotas, but the U.S. efforts failed. Now, President Biden has said there will be "consequences" for Saudi Arabia as a result of OPEC+'s decision. It is not clear what these consequences may be or if they will be significant to the oil market. One issue that is being discussed is reviving the NOPEC legislation. If passed, this would make it possible for the Attorney General to sue OPEC producers for anti-competitive practices. This could disrupt the global oil market and potentially raise oil prices. This outcome is highly unlikely. Other potential reactions are not likely to impact the oil market.