The OPEC+ alliance has been waging an uphill battle to raise oil prices through ever-deepening production cuts for the past nine months but, so far, its efforts have fallen short of expectations. Price gains have been tempered by persistent worrying developments in the fragile global economy and higher output by both OPEC+ members and countries outside the alliance.

But the OPEC+ group of 13 OPEC members and 10 non-OPEC producers may soon see a reversal of fortunes as the global supply and demand balance tightens in coming weeks and months. Just as demand growth gathers pace in the third quarter, the full force of Saudi Arabia’s production cuts will start working their way into the market by early August at latest, and the loss of output will continue to deepen through September.

Underscoring Saudi Arabia’s unwavering commitment to boost oil prices, for the third time in four months Saudi Energy Minister Prince Abdulaziz bin Salman announced July 3 that his country would again voluntarily reduce output, extending its July production cut of 1 million barrels per day through August. This follows voluntary supply cuts for June and July of 500,000 b/d and 1 mb/d, respectively. The kingdom’s crude production will drop to just 9 mb/d for July and August, a level not seen since 2010, barring extraordinary cuts at the start of the coronavirus pandemic, according to OPEC’s “2023 Annual Statistical Bulletin.”

Saudi Arabia’s announcement, which was followed by a pledge from Russia to reduce supplies to the market by 500,000 b/d and Algeria by 20,000 b/d in August, was made leading up to the group’s July 5-6 semiannual International Oil Seminar. This was the third time a decision to voluntarily implement lower production was made outside the normal meeting structure, which likely reflects the kingdom’s concerns of a weak economic outlook as well as disappointment by the market’s response to previous cuts.

Following the muted price impact to the June 3 decision to slash output, the Saudi energy minister said June 11 that the oil market is working amid “uncertainties and sentiments,” at the 10th Arab-China Business Conference in Riyadh, adding the uncertainties are why “we are taking these precautionary measures.”

Oil Prices Breakout Above $80 per Barrel After Saudi Announcement

Saudi Arabia’s latest cut may prove that the third time is a charm. International Brent crude oil, the price benchmark for two-thirds of the world’s oil supplies, are now flirting near $84/bbl, up by a significant $9/bbl since the July 3 announcement, the first substantial increase since the May cuts were announced. Prices broke through the $80 per barrel threshold July 12 but edged lower again on renewed worries about the fragile economic outlook, especially for China. On July 17, China reported economic growth for the second quarter that was well below expectations. Prices reversed course yet again on nascent signs oil supplies were finally starting to tighten and after China indicated it would implement stimulus measures to boost its flagging economy, with Brent steadily rising toward $83.90/bbl. Brent prices for the front month September futures settled at a three-month high of $83.64/bbl July 25. Prices have now broken out of the narrow $75/bbl trading range that marked much of May and June, posting gains for the fourth straight week in a row in July and establishing a higher trading range of $79/bbl to $84/bbl, but it is still unclear if the upward momentum can be maintained. The ICE Brent October contract is trailing the September contract at around $83.20/bbl.

Nonetheless, current oil prices are still well below the $90/bbl to $100/bbl range many analysts predicted and are also well short of higher OPEC+ price aspirations. OPEC+ formally reduced production quotas by 2 mb/d, effective November 2022, followed by three voluntary production cuts taken since April 2023 by several member countries, led by Saudi Arabia, aimed at tightening the supply and demand balance and boosting prices. The October 5, 2022 decision to implement cuts in November took place amid a steady decline in prices after an early March peak of near $128/bbl in the wake of Russia’s February 24 invasion of Ukraine. Ironically, despite the massive OPEC+ supply cuts, recent Brent prices are still trading about $4-5/bbl below levels posted in late September 2022, just before the October decision, and are a steep $44/bbl below the 2022 peak level.

Since its seminal meeting in October 2022, OPEC+ has reduced production (along with voluntary cuts by some individual members), at least on paper, by a staggering 5.3 mb/d through August. From November 2022 through June, actual supplies by OPEC+ countries that have committed to lower output levels are down by around 1.8 mb/d compared to pledges to cut production by 3.66 mb/d for the period. The International Energy Agency noted in its July “Oil Market Report” that lower output by the 19 members of the OPEC+ alliance taking part in the cuts has largely been “offset by higher output from other producers.” The IEA added that, “In June, global oil supply was a mere 70 kb/d below October levels just before the first round of OPEC+ cuts kicked in.” Notably, Iran, which is not part of the agreements due to sanctions, increased production by a substantial 530,000 b/d on average from November 2022 to June. At the same time, supply from the United States rose an even stronger 610,000 b/d over the same period.

While supply levels marginally eclipsed demand in the first half of the year, the balance is about to shift in favor of the latter. Global oil demand growth is forecast to increase sharply in the second half of the year, led by a resurgent China, while supply will contract, not least because of the further loss of 1 mb/d from Saudi Arabia in July and August.

Ambiguity in the Macroeconomic Outlook Behind Diverging Market Views

Many oil analysts and traders have been expecting a strong economic rebound in China, coupled with sharply lower OPEC+ production, would lead to higher prices above $85/bbl and closer to $100/bbl range in the second half of the year. However, the prolonged economic uncertainty and especially disappointing growth in China have led to diverging outlooks for oil demand. Tighter monetary policies, including persistent interest rate increases in the United States, Europe, and developing countries, are tempering economic growth prospects, which may yet weigh on oil prices for the remainder of the year. “There is a lot of ambiguity” in the macroeconomic picture, OPEC Secretary General Haitham al-Ghais said in a July 6 interview with CNBC.

After prices breached the $80/bbl threshold, Citigroup’s veteran analyst Ed Morse argued that, “The bulls got it all wrong.” He added, “The world is still waiting for a real Chinese recovery, Europe is in recession and we still don’t know if the US will have a hard landing.” Morse sees Brent at around $83/bbl for the summer months.

Striking a more optimistic note, Saudi Aramco CEO Amin Nasser noted that prices were under pressure from economic headwinds and that there are “recessionary signs everywhere.” However, he added that “China’s still picking up” and suggested he was “optimistic” about demand growth.

The latest supply and demand monthly reports from major forecasting organizations depict differing demand growth trends for the second half of 2023. In its July “Oil Market Report,” the IEA downgraded its 2023 oil demand forecast by 200,000 b/d for the first time this year, while the OPEC Secretariat raised its outlook by 100,000 b/d for the year in its “Monthly Oil Market Report.” At the same time, the U.S. Energy Information Administration’s July 11 “Short-Term Oil Outlook” revised its global demand outlook lower for the third quarter by 150,000 b/d but raised it by a similar amount for the fourth quarter.

For the second half of the year, the IEA forecasts oil demand outstripping supply in both the third and fourth quarters, with a sharp drawdown in global stocks needed to fill the gap over the remainder of the year, at just over 1.9 mb/d in the third quarter and almost 1.45 mb/d in the fourth quarter.

The EIA forecasts that global oil inventories will decline over the next five quarters. As a result, lower global inventories will add upward pressure on prices, with spot prices for Brent crude oil “reaching about $80/bbl in 4Q23 and averaging about $84/bbl in 2024,” according to the EIA. This compares with annual Brent prices of $101/bbl in 2022.

Underscoring its outlook for much tighter balances going forward, the IEA projects that global oil demand will rise by 2.3 mb/d in the second half of the year over the first six months. By contrast, OPEC and the EIA forecast smaller increases of 1.17 mb/d and 1.25 mb/d, respectively.

For the year as a whole, both OPEC and the IEA forecast strong year-on-year oil demand growth, at 2.4 mb/d and 2.2 mb/d, respectively, while the EIA projects smaller gains of around 1.75 mb/d.

All Roads Lead to China

In tandem with lower OPEC+ supplies, Chinese oil demand growth may help drive a higher price trajectory for the remainder of the year, with the country’s oil consumption projected to rise by 1.6 mb/d year-on-year, accounting for a steep 70% of the global increase in 2023, according to the IEA. Following the lifting of coronavirus restrictions at the end of 2022, China saw a resurgence in oil demand as leisure activities returned, road transportation increased, and airline travel resumed, especially for international air traffic in the first half of the year. However, all three major forecasting organizations see Chinese consumption in the third quarter easing from the loftier levels in the January-June period, when pent-up demand prevailed following the lifting of severe pandemic restrictions at the end of 2022. Demand is projected to rebound in the fourth quarter as the post-pandemic recovery continues. Robust petrochemical feedstock use, fueled by the startup of new plants, is expected to support higher demand growth of around 600,000 b/d in the fourth quarter, according to OPEC’s July report.

At the same time, uncertainties abound over the outlook for China. The recovery in the service sector has been undermined by weaker consumer confidence amid high youth unemployment. Export activity has slowed as high interest rates in the United States, Europe, and many parts of Asia weigh on purchases of the country’s products. And a struggling property sector may yet pressure growth.More Chinese government measures and incentives to stimulate the economy may be needed to support the higher oil demand growth levels. In recent weeks, a number of measures have been announced aimed at supporting stronger economic growth by increasing consumer and business spending, but the details on the plans have been vague. More concrete policy regulations and stimulus programs are needed to encourage stronger growth, analysts argue.

In addition, China embarked on a massive crude oil buying spree in recent months, which has led to the country’s stock levels reaching near all-time highs going into the second half of the year. China has been taking advantage of heavily discounted Russian and Iranian crude to fill its tanks in recent months, with oil imports setting new records in the second quarter. China imported 2.57 mb/d of Russian crude in June, breaking a record set in May. With storage tanks topped up, any slowdown in demand will reduce imports in coming months, removing a major support of higher prices.

While Brent oil futures are closing in on price levels posted just before OPEC+ agreed to its first round of cuts in early October 2022, the slow speed and pace of the price increases may yet lead to a further extension of Saudi Arabia’s 1 mb/d reduction for September, or even longer if prices fail to reach a higher $85/bbl to 90/bbl threshold in the very near term. The OPEC+ Joint Ministerial Monitoring Committee will hold an online meeting August 4 to review the market outlook.

Saudi Arabia’s energy minister recently said that, “To understand OPEC+ today, it’s all about being proactive, preemptive, and precautionary.” Given Prince Abdulaziz’s penchant to spring surprises on the oil market, the next “proactive” move to impact prices is anyone’s guess. However, there is one certainty: Once the higher price target is finally reached, unwinding the supply cuts will be an equally slow, arduous process as the kingdom seeks to make up for lost revenue this year.