Oil Prices Set to Soar as OPEC+ Announces Production Cut

Put another way, markets have just gone through a negative growth shock big enough to deliver a dovish shift in Fed policy, but investors believe it will be contained enough that it does not spill over and cause a recession.

While the banking crisis is primarily contained, and markets appear to have shifted back to business as usual, discussions on policy implications continue to center on a Fed pause and eventual rate cuts.

WHAT’S NEXT

Indeed it seems likely the acute phase of the banking turmoil has passed, and the key going forward is what impact recent developments will have on bank lending and the real economy.

Markets could be facing an evolving conundrum; the rat-a-tat-tat of negative news on banking corners has slowed, and the feeling of “more shoes to drop” has left, but now the questions have turned to “what’s next.”. Well, I think the OPEC supply cut is what’s next.

But even suppose the policy support was strong enough to keep the broader economy out of harm’s way. In that case, hikes can continue, and the Dollar can strengthen as markets unwind the degree of policy substitution (credit tightening for rate hikes)that will be warranted.

If the economic fallout remains more modest, and core inflation pressures are cooling only slowly as Friday’s PCE data suggest, and now that OPEC has cut supply, oil prices could soar, expect the Fed to get more attention. Put another way; there is a limit to the extent that “good news” on the banking front can be priced alongside a more dovish Fed now.

Oil

Nine members of OPEC+ announced today a surprise “voluntary” collective output cut totaling 1.66mn b/d, which will take effect from May till the end of 2023.

Given the lack of alternative non-OPEC supply, the group has significant pricing power relative to the past. And to the dismay of global leaders, OPEC has decided to draw a hard line at Brent $80 per barrel for self-serving economic interests. But this surprise cut is consistent with their new doctrine to act pre-emptively because they can do so without significant losses in market share.

The stated frustration of the producer group with the Western energy policies, including the price cap on Russian Oil, SPR releases in the US—which announced a surprising 26mb additional release in February but, importantly, the refusal to refill those coffers in the fiscal year 2023 after WTI reached lows that were previously indicated as adequate levels to refill may have contributed to the OPEC+ decision to cut too.

Once again, OPEC+ implements a precautionary production cut like in October 2022. However, unlike then, the momentum for global oil demand is up, not down; with a strong China recovery, the Brent forward curve is in “backwardation,” and refining margins remain resilient.

Moreover, given how short positioning has become, the risks around cutting production will result in bullishly skewed price action. Price increases in response to tightening events can be more substantial when the market is short.

The crude managed money long-short ratio remains very low at 2.5, the lowest since December 2022, and the Brent long-short ratio edged down further in Friday’s CFTC report.

While WTI’s positioning partly recovered last week, the OPEC surprise cut is a bullish Brent event unambiguously.