Death By 1.15 Million Cuts

By Benjamin Picton, senior macro strategist at Rabobank

OPEC stunned the market late on Sunday by announcing oil production cuts of around 1.15 million barrels per day. The announcement, strangely, came ahead of the actual OPEC meeting scheduled for today, and throws another spanner in the works for central bankers who may have just started to unclench their jaws a little with regards to the inflation situation. Indeed, US PCE inflation on Friday fell to 5.4% y-o-y, down from 5.3% a month earlier and a tick better than expected, but preliminary Eurozone core CPI actually lifted from a month earlier even as the headline figure fell by more than the Bloomberg survey had predicted.

The durability of declining headline inflation must now be seriously questioned if oil producing countries are determined to ensure that oil prices have already bottomed. Rabobank’s energy expert, Joe DeLaura, had already seen Brent crude prices testing $85/bbl by the end of the year –as it is already is today– and $100/bbl in 2025. The critical factor for central banks may now shift to the level at which those declines are likely to stop. Is it really going to be 2%?

The OPEC+ production cuts come on top of the 500,000 bbl per day reduction announced by Russia in early March, and highlight how susceptible the economic outlook remains to (deliberate) supply shocks. The US response until now has been to release oil from its Strategic Petroleum Reserve (SPR), which has reduced stocks to its lowest level since the early 1980s. US Energy Secretary Granholm recently told Congress that it could take “years” to refill the SPR: the OPEC cuts may stretch Granholm’s timeline even further as crude prices get pushed further away from the levels at which the Biden Administration is happy to be a buyer.

There is clearly an element of ‘oils ain’t oils’ about this, as energy is intensely political. For one example, the $60/bbl EU price cap on Russian exports, which Japan has just breached with permission, may soon have to be addressed by others if price rises are sustained. For another, see recent Japanese criticisms of Australia “quiet-quitting” the LNG market.

But far more importantly, the new OPEC+ cuts are led by Saudi Arabia, which will drop output by 500,000 bbl, which is likely to further stoke tensions with the Biden administration, who were unhappy with Saudi unwillingness to increase oil output last year to help bring inflation under control, and as recent diplomatic developments in the Middle East show a closer relationship between Riyadh and Beijing.

Naturally, against this backdrop we also hear renewed chatter of the CNY challenging the US Dollar’s dominance. However, this certainly isn’t the first time that fears over the Dollar reserve system have flared, and as Michael Every describes here, the death of the Dollar-based system is much exaggerated, and will likely end badly for those challenging it even if it were to occur.

Nonetheless, this issue is clearly likely to linger through the week after the OPEC+ headline, even for those who don’t pay much attention to these kind of paradigmatic issues, at least as long as it is centered on oil, and hence inflation.