Sharp oil production cuts: will the OPEC kill the golden goose?

 

opec worries

If you showed an arc to a good mathematician, said Emerson in one of his famous essays, the former would complete the circle. 

This is exactly what we saw in the oil markets this week: smart investors looked at the dots in the charts that really matter and completed the picture on their minds that most analysts, traders and investors do not see.

In short, they exercised caution in exact response to what they see, as going with the flow was never in their character.

As a consequence, oil price that showed a remarkable recovery during the second phase of the pandemic lost its momentum this week, much to analysts’ surprise.

On one hand, the measures taken by the Western governments to keep the pandemic at bay do not seem to be doing the trick; the leaders, having listened to endless experts, are really in a quandary without knowing how to move forward; the progress made on the vaccine front so far is doing very little to shore up the loss of enthusiasm in it by the public, something often blamed on misinformation.

On the other hand, the risk of oversupply is growing by the day: there seem to be plenty of political manoeuvres to ease the sanctions against Venezuela on humanitarian grounds; Iranians show optimism by increasing the production of oil, sensing the easing of sanctions; Libya is increasing its production too, hoping that the political upheavals will be sorted out in the near future.

In these circumstances, the production cuts, made by the OPEC+ under pressure from its more powerful members, do not seem to be a productive move in the long run, although it must have favoured the block in the short run.

In addition to the production cuts, agreed upon at the recent OPEC+ summit, Saudis went even further on their own by cutting down the output by 1 million barrels per day.

In the presence of such a move, certain members such as the UAE, were forced to warn shale producers not to flood the market with excess oil, which is highly unlikely to happen; the suffering of the shale oil producers predates the pandemic, when oil price dropped significantly.

Saudi Arabia was instrumental in that development too, as it did not cut down the output, hoping that the shale producers would struggle to survive when the oil price remained low due to oversupply.

Although, it did the trick in the short-run, shale oil producers sharpened up their ingenuity in order to minimize the production costs while cushioning the impact. In short, the shale oil producers had bruises, but did not bleed to extinction.

Facing the prospect of dealing with a huge budget deficit, Saudi move to cut the crude oil output is understandable.

Elevating the same strategy to a place a few notches above on their ambition index, in the current circumstances, however, is neither productive nor sustainable – especially when a new team is in the White House with a revolutionary agenda.

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