- OPEC+ voluntary production cuts failed to counter economic concerns, as prices dropped back down after initial increase
- China's weak oil demand in Q1 2023 raises concerns about global demand and economic weakness
- Production cuts may not be enough to combat the perception of falling demand, and traders should watch for government actions in India and China
It took just three weeks for the oil market to digest OPEC+’s surprise voluntary production cuts. After OPEC+ announced on April 2 that starting in May, producing nations would be cutting a total of 1.16 million bpd, Brent jumped up 6% to $85 per barrel, and WTI rose to $80 per barrel. Now, just over three weeks later, prices are back down to where they were at the end of March. Brent traded below the $80 per barrel mark on Wednesday.
Economic Concerns Outweigh Supply Concerns
At the end of 2022, the banks and their forecasting institutions all predicted that we would see the return of triple-digit oil prices in 2023. The concern then was that demand would outpace supply. Many believed that China’s reopening would produce a very strong rebound in demand and that the sanctions and price cap policies implemented by the U.S. and EU on Russian seaborne oil exports would hurt global supply. However, with China, we have seen consumer demand return steadily, but industrial demand indicators have been mixed.
In fact, based on information about China’s refinery runs, oil imports, and petroleum product exports, it appears that domestic oil demand in China in the first quarter was soft. Fewer petroleum products were consumed domestically even though refinery runs were strong, so more products went into inventory.
China could be storing up for later in the year when it may expect to see higher oil prices, or it could just be experiencing weaker-than-anticipated demand. China could also pump up its industrial demand with stimulus, but global economic weakness could mean problems with China’s manufacturing sector that the Communist government can’t fix domestically.
Every time concerning economic data from the U.S. or the EU is released, oil prices react and head downward. Last week, it was moderately higher unemployment numbers in the U.S. and an unexpected build in U.S. gasoline inventories.
This week, it was data from the Dallas Fed’s Texas Manufacturing Survey that showed little growth in manufacturing and a near-zero production index. These data don’t necessarily portend a global economic slowdown, but the market is so jittery that every piece of data is met with an exaggerated movement in oil prices.
OPEC+ Was Right, but Are Production Cuts Enough?
Even the Biden administration must admit, at this point, that OPEC was right to cut production last October and it was right to do so in April. OPEC claims it is trying to prevent a plunge in oil prices like the one that occurred in 2008 and required emergency action by OPEC. Others claim OPEC is trying to lift oil prices because the governments’ of producing nations need more money.
Regardless of OPEC’s true reasons for cutting production, it is clear that the group can still impact prices by altering the supply of oil. However, this may not be enough to combat the perception of falling demand. OPEC’s April surprise had a strong price impact because it was a surprise. That element is now gone, as the market will now anticipate OPEC cuts even if the group says production will remain steady.
As we move into the summer months, when oil demand is typically higher, and the OPEC cuts start to impact global supply, we will have a better idea of whether OPEC action is enough to stave off a price drop caused by demand weakness, or if other action on the supply and demand will be needed to keep prices from falling further.
Volatile Future
This portends a volatile near-term future for oil prices. The oil market is primed to react to any and all economic indicators that hit the news. OPEC+ has also shown itself ready to step in to lift oil prices with production cuts to the extent that it is able, though even time it takes action, its action will be less potent.
Traders should keep an eye on economies like India and China that may take government action to increase domestic demand for oil, especially if prices are relatively low and even cheaper Russian oil is readily available.
***
Disclaimer: The author does not own any of the securities mentioned in this article.