What the surprise oil production cut by OPEC+ means

  Oil markets are reeling after OPEC+ said in a surprise announcement on Sunday that it would cut up to 1.15 million barrels a day in its target production starting next month. The announcement comes on top of Russia’s intentions to reduce its own production by 500,000 barrels per day from February levels by the end of the year. Put together, those two cuts make for a total potential voluntary reduction of more than 1.6 million barrels per day in global supplies. The OPEC+ announcement shocked global markets because the group had indicated that it would hold oil supplies stable. Crude futures had recently recovered to almost $80 a barrel, leading most analysts to conclude that OPEC+ would hold its production steady. But Saudi Arabia is seeking higher prices and has recently been more willing to flex its muscles on the global stage. Saudi Arabia and Russia lead the overall reductions at 500,000 barrels a day each. OPEC+, which includes its leading producer, Saudi Arabia, and Russia, produces about 40% of the world’s crude oil.

Impact on inflation

The cuts come with serious implications, particularly when it comes to inflation. Consumer economies are already struggling, and reducing the output of oil on the global market creates an imbalance between supply and demand that could fuel inflation. That, in turn, could cause demand destruction through higher prices. In short, a move intended to stabilize the market could result in just the opposite. “The move to cut production is a sign of weakness around a global oil glut and a soft global economy,” said RSM US Chief Economist Joseph Brusuelas. “This will create inflationary pressures, higher policy rates and slower growth leading to weaker demand. Should the weak demand for oil and slower growth turn into a global recession, then the inflation turns into disinflation. Saudis are making a big policy mistake.”

The takeaway

While we will see a price spike in the short term, historical data has proven that similar surges have failed to materialize into long term-price stability. We expect that the longer-term impact of the production cuts is bearish for oil prices.