The oil shock that could tip the global economy over the edge

The Saudis pledged to cut their output by 500,000 barrels a day, with Kuwait, the United Arab Emirates, Algeria, Iraq, Kazakhstan and Oman also promising to reduce their production. As was the case in October, many of them are already producing at levels below their OPEC-agreed quotas and won’t actually have to cut production to meet their new targets.

The other country that joined that group was Russia, which said it would extend the 500,000 barrels a day supply reduction it announced in February. That reduction was supposed to run from March to June but will now be extended through to the end of the year.

When Russia announced that cut in early February it was supposed to be in retaliation for the Western sanctions on its oil, which force anyone shipping Russian oil on vessels that are insured by the European and US companies who dominate the sector, to observe a G-7 cap of $US60 a barrel on Russian oil.

It is estimated that at least half of Russia’s oil exports are carried on vessels whose cargo is subject to the price cap. The rest would be carried on the vast “shadow fleet” of tankers Russia has assembled to try to circumvent the cap.

There are analysts who believe that Russia’s “retaliation” was designed as a cover-up for falling production from its more complex fields after the withdrawal of Western companies and their technology that have been important in sustaining production, particularly in the challenging Siberian environment.

In any event, those “cuts” had little, if any, impact on oil prices, which kept falling, as have Russia’s oil revenues.

Whether the latest cuts produce the effects the Saudis and the other oil states are seeking will be dependent on the performance of the global economy through the rest of this year.

The International Energy Agency said last month that Russia’s oil export revenues were 40 per cent lower than a year earlier, with a weighted average price of $US52.48 a barrel that was significantly below the $US60 a barrel cap. The average price for Russia’s flagship product, Urals crude, was $US45.27 a barrel.

That’s consistent with official Russian data that showed Russian government revenue from oil and gas sales nearly halving in January from a year earlier. The price cap was set in early December, and caps on Russian exports of diesel and other refined products in February, so the squeeze on Russia’s revenues will have tightened further.

Even if oil prices were to rise as a result of the latest cuts, those caps would remain and Russia would therefore receive lower prices on reduced production volumes. The cargoes carried on its own fleet are priced at a discount to global prices because of the leverage the two main buyers – China and India – have in negotiations. It also costs more to ship to Asian markets than to Russia’s previous core markets in Europe.

If Russia’s production cuts are real, their extension would (if the other cuts announced on Sunday were also real) reduce OPEC+’s output by 1.6 million barrels a day in the second half of this year relative to what the market had been anticipating. In theory, at least, when combined with last October’s cuts to output that’s a reduction of about three per cent of global production.

Not surprisingly, the Biden White House, anxious to keep a lid on US fuel prices and maintain the slow progress the US is making in bringing its inflation rate down, isn’t amused by the OPEC+ announcement, calling it “ill-advised.”

Relations between the administration and the Saudis have been tense since the Saudi’s ignored the administration’s pleas to maintain production – Joe Biden even made a trip to the region to press his case – and went ahead with the announcement of last October’s cuts.

Whether the latest cuts produce the effects the Saudis and the other oil states are seeking will be dependent on the performance of the global economy through the rest of this year.

Most of the developed economies are still grappling with inflation and their interest rate settings are choking their growth rates.

In the US, its regional banking crisis will have a chilling effect on the flow and price of credit in the US and, because of the primacy of its financial system, potentially elsewhere.

In Europe, the war in Ukraine, as well as increased energy costs and still-elevated inflation rates will depress growth.

China has bounced back since dropping its zero COVID policies and reopening its economy but is targeting only (by its standards) modest growth of about five per cent. With Chinese consumers still cautious, local government finances stretched, its property sector only just starting to stabilise, and its export markets subdued, that target is relatively ambitious in the circumstances.

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It is therefore conceivable that, absent an unexpected surge in global economic growth – which would force a central bank response to the inflationary pressures that it would generate – rather than causing oil prices to spike the move by the OPEC+ members who signed up to the latest cuts may just put a floor under the price in line with the weak outlook for global growth.

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