The abrupt April 2 decision by the OPEC+ alliance of OPEC and non-OPEC oil producers to cut production blindsided oil markets in a bid to support a higher price floor closer to $85 per barrel. Oil and financial markets were caught off guard by the unexpected announcement that a select group of OPEC+ producers, led by Saudi Arabia, had agreed to reduce output by 1.16 million barrels per day starting in May. At the same time, Russia announced it would extend its previously planned cut of 500,000 b/d for March through the end of 2023, bringing the total of new voluntary cuts to 1.66 mb/d through December 2023.

Oil futures prices jumped over 6% when markets opened April 3, with international benchmark Brent crude closing the day near $85 per barrel, an increase of over $5/bbl from levels posted immediately before the OPEC+ agreement was announced.

The alliance’s precipitous decision also sent shockwaves through financial markets and heightened concerns about the global economic outlook, including the possibility of further inflation and interest rate increases by central banks. Moreover, the announcement prompted fears of even sharper supply shortages amid expectations of stronger demand growth in the second half of the year, with some analysts raising price forecasts by up to $5/bbl to reach between $90/bbl and $100/bbl by the end of 2023.

Fall in Oil Prices Was a Flashpoint

Speculation abounds as to what triggered the abrupt production cuts. Officially, OPEC+ said the new cuts were a precautionary measure aimed at supporting the stability of the oil market. There are myriad factors that may have contributed to the unexpected decision, but a decline in the price of Brent crude to just below $73/bbl, a drop of $13/bbl in less than two weeks amid the banking crisis and wider concerns about a collapse in financial markets, most likely spurred the move. Reflecting the more pragmatic price view, Dmitry Peskov, Russian President Vladimir Putin’s press secretary, said the cuts were aimed at keeping “world oil and petroleum product prices at the appropriate level.”

The decision nonetheless opened the door for wider conjecture among oil analysts and commentators on the rationale behind the cuts, given the outlook for strong demand growth. Some analysts believe the worsening relationship between Riyadh and Washington may have prompted the cuts, with the latter arguing that increased oil prices will exacerbate already high inflation levels undermining the global economic recovery from the coronavirus pandemic. This is the second time OPEC+ has rankled the administration of President Joseph R. Biden Jr. with production cuts in the past six months.

Ahead of the October 2022 OPEC+ meeting, Washington unsuccessfully lobbied the group to maintain higher output levels to cool prices, leading Biden to vow that there would be “consequences” for Saudi Arabia. This time around, the reaction was more muted. While it’s possible that the latest decision was yet another step by Riyadh to exert its independence from Washington, strained ties may have played no role at all. The kingdom has increasingly adopted a “Saudi-first” approach in recent years, putting its own economic interests front and center.

Some reports suggested the cuts were aimed at punishing traders betting on falling prices in response to the banking crisis. OPEC+ delegates pointed to market data on the buildup in short selling as an explanation for the decision, Bloomberg reported. Some OPEC+ officials, particularly Saudi Energy Minister Prince Abdulaziz bin Salman, have long seen short sellers as a thorn in their sides. In 2020, he famously said, “I’m going to make sure whoever gambles on this market will be ouching like hell.” His comments apparently resonated with traders again when the surprise April announcement caused their profits to unravel. Whether by design or as an unintended consequence, bullish oil bets surged to the highest level since 2016 following the agreement.

Markets were also caught off guard by the decision because numerous OPEC+ officials told reporters in the weeks leading up to the announcement that the group would stay the course with its production targets through the rest of the year. The sudden shift away from maintaining the status quo also runs counter to the policy of providing a stable, forward-looking scenario to underpin market stability that prevailed during the coronavirus pandemic.

OPEC+ promptly slashed production as global oil demand collapsed at the start of the pandemic and then deftly orchestrated a steady rise in output as the world economy began to recover. Throughout the height of the pandemic, the group met monthly to discuss its production strategy and clearly communicated its plans, providing a farsighted perspective amid the global turmoil. Such “forward guidance” is a key tool for preventing surprises that can disrupt markets and cause significant volatility in prices. As a result, the latest decision, made on a Sunday when markets were closed and without advance warning, caught the market off guard.

Equally, the unexpected banking crisis that emerged in early March triggered tumult in financial and commodity markets and sparked fears that contagion would undermine global oil demand growth. Given these unprecedented developments, coupled with a sudden plunge in oil prices, the rapid response by OPEC+ to curb supplies amid the potential for a contraction in demand growth aligns with its stated policy to quickly respond to market events and adopt precautionary measures to maintain market stability.

Oil Supply and Demand Expectations

Oil markets were penciling in prices closer to $90/bbl for the second half of 2023 based on expectations that global supplies would fall short of soaring demand primarily driven by a robust rebound led by China. The April oil market reports just released by the three primary international forecasting organizations still expect demand growth to accelerate through the end of the year, though projections of the impact of the cuts are somewhat mixed, underscoring uncertainty about demand growth. The International Energy Agency forecasts 1.47 mb/d in oil demand growth from the first half of 2023 to the second half. OPEC expects growth to increase by around 1 mb/d over the same period. And the U.S. Energy Information Administration projects a smaller rise of about 700,000 b/d.

The EIA said that while the OPEC+ cuts are significant, growing global production, especially in North and South America, would offset lower supply levels. “We expect that world oil production and demand for petroleum products will be relatively balanced this year,” said EIA Administrator Joe DeCarolis. As part of EIA’s Short-Term Energy Outlook, a special supplement detailing growth in non-OPEC production underpins the forecast released April 11. The report revised prices for Brent crude marginally higher to an average $86/bbl for the rest of 2023.

By contrast, the IEA’s April Oil Market Report stated that the “surprise OPEC+ supply cuts … risk aggravating an expected oil supply deficit” in the second half of 2023 “and boosting oil prices at a time of heightened economic uncertainty.” The IEA left its demand forecast unchanged from its previous report, with growth of 2 mb/d in 2023 reaching a record total of 101.9 mb/d. But in contrast to the EIA, the IEA’s report noted that “new OPEC+ cuts could reduce output by 1.4 mb/d from March through year-end, more than offsetting a 1 mb/d increase in non-OPEC+ production.”

OPEC’s own April Monthly Oil Market Report also left world oil demand largely unchanged for 2023. However, somewhat contrary to the recent decision to cut production, OPEC’s latest report projects a sharp 2.57 mb/d increase in demand growth from the second quarter to the fourth quarter, suggesting a significant drawdown in global oil stocks will be needed to meet stronger demand growth.

Market Outlook Uncertainty Abounds

A multitude of factors could yet derail current expectations. The EIA’s report warned that escalating risks in the “U.S. and global banking sectors increases uncertainty about macroeconomic conditions and their potential effects on liquid fuels consumption,” adding that demand growth could be lower than the current forecast.

Moreover, the impact of the OPEC+ cuts on prices may be tempered by slower economic growth. “Global economic activity is experiencing a broad-based and sharper-than-expected slowdown, with inflation higher than seen in several decades,” the International Monetary Fund stated in its April 11 World Economic Outlook. The IMF slightly trimmed its forecast for global gross domestic product growth to 2.8% for 2023 and 3% for 2024, down from 3.4% in 2022. Notably for oil markets, the IMF left its forecast for China’s GDP growth of 5.2% unchanged from its January outlook.

The level of compliance among OPEC+ members taking part in the April agreement to cut production beginning in May will also be a key driver of prices. Compliance is expected to be more robust than it was with the November 2022 agreement, when 19 countries pledged to reduce production by 2 mb/d. OPEC+ is made up of the 13 members of OPEC and 10 non-OPEC producers, but Iran, Venezuela, and Libya are excluded from agreements due to sanctions or chronic civil unrest disrupting production. Some countries, such as Nigeria and Angola, were already producing well below quotas due to capacity constraints, making their reported contributions nominal. As a result, actual supplies to oil markets were only down by an average 600,000 b/d to 800,000 b/d from November 2022 through March.

However, the April OPEC+ agreement is expected to produce stronger compliance, in large part because most of the participating countries are some of the alliance’s most prominent producers. Saudi Arabia, Kuwait, Iraq, and Azerbaijan all produced at or cut even more than their November targets, which bodes well for compliance with the new May targets.

However, complete adherence to the new targets is not guaranteed. Russia remains a key unknown. The country’s production has remained largely unchanged since November despite an expected cut of just over 500,000 b/d. Russia has consistently defied expectations of sharply lower production this year in the wake of its invasion of Ukraine and a ban on imports of Russian energy supplies by a group of Western countries. However, Russia has largely circumvented sanctions by rerouting its crude to countries that haven’t joined the sanctions campaign, such as India and China. Russia has now pledged to reduce output by a further 500,000 b/d, but it remains uncertain whether Moscow can resist the temptation to maintain both higher production and oil revenue amid the financial strain of its war in Ukraine.

The next OPEC+ ministerial meeting is scheduled for June 4 in Vienna. If recent developments indicate a much tighter supply and demand balance is emerging, the voluntary production cuts can be unwound just as easily as they were agreed to.