Oil Production Cuts: A Punch in the Mouth?
As former heavyweight champ Mike Tyson once said: “Everyone has a plan until they get punched in the mouth.”
The bull case for the stock market in 2023 was getting stronger…until overseas oil producers punched us in the mouth.
This week in a surprise move, the Organization of the Petroleum Exporting Countries and its allies (aka OPEC+) announced that they would cumulatively slash crude oil production by another 1.16 million barrels per day (bpd) until the end of 2023. It was the second reduction in output announced by OPEC+ in less than a year, after last autumn the oil cartel cut production by 2 million bpd.
The fight against inflation was dealt a grievous blow. The U.S. Federal Reserve, European Central Bank, and other central bankers are now faced with a dilemma. The increase in energy costs will fuel inflation around the world, which in turn will make it harder for monetary policymakers to ease up on tightening.
The move by OPEC+ sent shock waves around the world, exacerbating tensions between the cartel’s de facto leader Saudi Arabia and Western governments.
OPEC+ partner Russia has enlisted the Saudis in a pressure campaign on the U.S. and European Union, due to sanctions imposed on Russia for its invasion of Ukraine. The plan is for the energy crunch and concomitant inflation to break the resolve of Western leaders who support Ukraine.
But OPEC+ has a history of getting punched in the mouth, too. As I explain below, damage from the latest OPEC+ production cut might be less than investors fear.
The best laid plans…
Mohammed bin Salman Al Saud, colloquially known as MBS, is Crown Prince of the House of Saud and Prime Minister of Saudi Arabia. To his critics, “MBS” also stands for Mr. Bone Saw, for the way his secret police tortured, dismembered, and murdered a Saudi journalist critical of his regime. As it has done with Russia, the West has criticized Saudi Arabia for human rights violations.
Saudi Arabia and Russia, the dominant voices in the OPEC+ cartel, are eager to shore up oil prices as a matter of economic self-interest. The oil cartel fears that a possible global recession this year could undermine oil prices. Indeed, before the latest announced cut, crude prices had been in a downward trend. In the wake of the production cut news, crude prices have been soaring.
The new cut, which takes effect in May, also presents an opportunity for political retribution against Western democracies, which Saudi Arabia and Russia view as holier-than-thou hypocrites.
But OPEC+ has a way of getting hoisted by its own petard.
The Saudis launched an oil price war in 2014. By throwing open the spigots, they drove down the price of oil. Their goal was to bankrupt U.S. shale producers.
The Saudi plan backfired. Spectacularly. The 2014-2016 collapse in oil prices, due to a growing supply glut, temporarily posed an existential threat to the Saudis.
The fracking technology devised by U.S. engineers was so ingenious, domestic producers were able to pump oil at far lower cost than OPEC+ producers. Many American energy producers were able to stay profitable, while OPEC+ lost market share and a massive amount of revenue.
Another strategic blunder occurred in 2020. In March of that year, during the nadir of the COVID pandemic, Saudi Arabia launched an oil price war with Russia, which led to a 65% quarterly fall in the price of oil.
The price war was triggered by a breakdown in dialogue between OPEC+ and Russia over proposed oil production cuts to cope with COVID-induced demand destruction. Russia balked at cuts, because it wanted to seize the opportunity to drive American producers out of business.
The price of oil became negative (that’s right…negative) on April 20, 2020. The negative price meant that traders were trying to offload unwanted oil but expensive oil storage was overflowing. Traders were paying people to accept oil. The following chart shows this unprecedented collapse:
This insane volatility prompted Saudi Arabia and Russia to finally agree to oil production cuts.
In 2014 and again in 2020, the stock market suffered collateral damage from these OPEC+ shenanigans. We’re seeing this effect play out again.
The main U.S. stock market indices closed mostly lower on Wednesday as follows:
- DJIA: +0.24%
- S&P 500: -0.25%
- NASDAQ: -1.07%
- Russell 2000: -0.99%
Payroll processing firm ADP (NSDQ: ADP) reported Wednesday that hiring in the private sector unexpectedly slowed in March. yet another sign that the U.S. economy might be slipping into a recession. The tech-heavy NASDAQ has racked up a three-day losing streak, as investors shift into defensive plays amid weak economic data and worries about rising oil prices.
But keep your perspective. OPEC+ has been steadily losing clout; market forces are in charge. When he invaded Ukraine, Russian President Vladimir Putin calculated that Europe would stay on the sidelines because the region is dependent on Russian energy. He bet wrong. Europe has done a remarkable job of finding energy from elsewhere.
OPEC+ is facing a splintered geopolitical landscape. Deglobalization has made the cartel’s efforts at market manipulation much tougher to pull off. What’s more, the latest production cuts and resulting rise in crude prices have increased the odds that interest rates will stay higher for longer…and hence, they’ve increased the odds of recessionary conditions that dampen energy demand.
Over the near term, the energy sector is now an attractive investment destination. Over the long term, it’s entirely likely that the latest move by OPEC+ will go down in history as yet another strategic blunder, and global economies will get off the ropes.
Editor’s Note: Volatility won’t end anytime soon. But there’s a way to profit from uncertainty…and my colleague Jim Pearce can show you how.
Jim Pearce is chief investment strategist of our premium trading services Personal Finance, PF Pro, and Mayhem Trader.
Through painstaking analysis, Jim has pinpointed one overlooked precious metal that could offer protection and massive profits, come hell or high water. Click here for details.
John Persinos is the editorial director of Investing Daily.