Adding Fuel to the Fire: the Consequences of OPEC+ Production Cuts

KSA

Energy Policy

Commentary

Dr. Sergey Sukhankin

On October 5, during its 45th Joint Ministerial Monitoring Committee meeting in Vienna, OPEC+ agreed to cut daily oil production by 2 million barrels per day, the biggest oil production reduction since the outbreak of the COVID-19 pandemic and the ensuing global economic slowdown. According to Saudi Arabia’s energy minister, Abdulaziz bin Salman, the real cut is likely to be between 1 and 1.1 million barrels. Following the decision, the price of Brent crude—the international benchmark for oil prices—jumped 4 percent to $96.47 a barrel. Some experts, such as Jorge Leon of Rystad Energy, have argued that prices could reach $100 by December. In addition to the immediate impact it will have on the global energy market, OPEC+’s decision could trigger major geopolitical and geo-economic transformations, the consequences of which may be even more far-reaching.

Deflecting Blame

Some experts have claimed that the decision to cut oil production was a purely political move designed to spurn President Biden and critical elements within the Democratic party ahead of the country’s midterm elections in November. Russian commentators shared similar insights, calling the decision a “slap delivered by Saudi Arabia and other Gulf actors to the acting US administration.” OPEC+’s official Saudi representative, however, denied any political motives behind the decision. The Saudi energy minister explained that compared to other hydrocarbons (such as natural gas and coal), oil remains underpriced on world markets. He also argued for “meticulous and long-term planning” toward the global energy market, where current needs—such as investing in non-renewable energy projects—should not be sidelined for the sake of transitioning to a clean energy future.

Experts from market intelligence solution organization ChAI argue that OPEC+ hoped to calm oil markets and challenge U.S. influence over member states’ oil production quotas. The production cut, they say, sent “a strong message to the U.S. that buyers will not dictate oil prices.” Other experts have pointed to fears about  inflation and “spare capacity” issues. That is, as it is rumored, the Saudi side lobbied so forcefully for the production cut because it fears that Russia’s production capacity will drop in 2023. In this contingency, Riyadh may eventually need to step in and replace the lost supply itself.

OPEC+’s decisions were dictated largely by the economic and political interests of Saudi Arabia, the grouping’s informal leader. It is clear that OPEC+ aims to maintain some spare capacity in case other major suppliers like Russia or Iraq are unable to meet future demand. It is also clear that OPEC+ leadership wants to keep oil prices around $100 per barrel. If necessary, OPEC+ may order further production cuts to maintain these prices. Given mounting fears of a deeper global economic downturn—and a subsequent collapse in oil demand—oil and gas-dependent OPEC+ members have a distinct interest in hiking energy prices to pad their coffers in the event of a future price collapse.

At the same time, one must also consider the geopolitical calculations of OPEC+ members, especially Saudi Arabia. U.S.-Saudi relations have hit an all-time low thanks to a muted American response to several attacks on the Saudi oil facilities by pro-Iranian militants, Washington’s harsh criticism of Saudi politics, and public accusations of political assassinations and human rights violations. This decay in relations, coupled with United States’ growing competition with Saudi Arabia in global energy markets, makes Riyadh’s incentive to partner with U.S. competitors like China and Russia evident.

Russia’s Stake

According to some reports, Russia was the first OPEC+ member to suggest the production cuts, though Saudi Arabia strongly favored the measure. Indeed, out of all OPEC+ members it is Russia—whose sanctions-crippled and war-drained economy desperately requires increased oil revenues—that is most concerned with keeping oil prices above $70 per barrel.

This factor is particularly salient, given the passage of the EU’s eighth package of sanctions against Russia on October 6. These restrictions imposed a “price ceiling” on Russia-supplied oil, as well as other measures that threaten Russia’s non-renewables industries. Moreover, Moscow has been forced to sell its oil at a considerable discount to some of its Asia-Pacific partners. As noted by Russian sources, even a dramatic increase in oil prices will not yield major gains, but it could help Russia cover some of the losses from these headwinds. In the meantime, Russia’s budget revenues from hydrocarbons are rapidly shrinking. According to Russian ministry of finance, drop of oil and gas revenues in August represented 13% decrease from July. The worst is yet to come, as the sixth and the eighth sanctions packages have yet to come into full force. Still, OPEC+’s decision is unlikely to save Russia’s ailing economy; its survival is inseparable from the longevity and outcome of its war with Ukraine.

Washington’s Riposte

The OPEC+ decision triggered swift and visible anger from leading politicians in the United States. President Joe Biden expressed his disappointment, calling the decision “shortsighted.” In the meantime, he directed the Department of Energy to uncork another 10 million barrels from the Strategic Petroleum Reserve (SPR) to counteract price spikes. Apparent frustration in Washington pushed president Biden to call for a re-evaluation of the U.S.-Saudi relations. As  U.S. Secretary of State Antony Blinken said recently, “[The U.S.] will not do anything that would infringe on our interests—that’s first and foremost what will guide us.” This doesn’t mean that the Saudi defiant behavior will go unnoticed or pass without an American retaliation.

At this juncture, the United States could implement a two-step policy to mitigate the consequences of OPEC+’s production cuts. First, the Biden administration could support U.S oil producers by increasing domestic oil production from shale (via hydraulic fracturing). Second, it is widely rumored that the U.S. administration could smooth ties or lift sanctions against Venezuela—one of the world’s largest oil-producing nations—so that Caracas could sell its oil on the global market, compensating for OPEC+’s reductions. It is rumored that Chevron could start transporting Venezuelan oil to U.S. and European markets. This would signal a profound shift in U.S. policy toward Venezuela, though the Russian invasion of Ukraine has made it a significantly more attractive option. That said, the outcome of the “Venezuelan option” will depend on the administration’s ability to overcome resistance from the groups within the United States and Venezuela.

 A New Paradigm

Observers can expect three main consequences of the OPEC+ decision to cut oil production. First, the decision throws cold water on the buoyant and cheerful sentiments—particularly visible in the West—about the inevitable and imminent net-zero transition. In fact, as the current economic crisis demonstrates, non-renewable energy and investments therein—including drilling wells, constructing pipelines and building new refineries—still play a central role to global growth. As OPEC Secretary General Haitham Al-Ghais rightly pointed out, “Energy security has a price.” Western countries that have bet on the green economy of the future over their current energy needs will likely pay a heavy price for their miscalculation.

Second, Saudi behavior, especially in the light of President Biden’s recent trip to the Kingdom, is likely to alter U.S. views of its heretofore strategic partner and its greater role in the Gulf region. Of course, the U.S. is not expected to abandon its partners or its interests in the region. As Biden clearly stated, “The United States is going to remain an engaged partner in the Middle East. We will not walk away and leave a vacuum filled by China, Russia or Iran”. At the same time, it is equally clear that Saudi Arabia does not have an alternative security guarantor. It will continue to rely on Washington’s military might to maintain strategic balance in the Gulf. Indeed, as the war in Ukraine has clearly demonstrated, U.S.-produced weaponry remains a game changer that Russian weaponry cannot match.

Finally, these developments mark the advent of a truly pivotal moment in EU energy policies. As has been openly stated by EU High Representative Josep Borrell, “Our prosperity has been based on cheap energy coming from Russia […] And the access to the big China market.” Stuck with rising oil prices and a lack of politically viable producers, Europe faces a potentially existential struggle to keep homes warmed—and its restless citizens content—this winter.

The views and opinions expressed in this article are those of the authors and do not necessarily reflect the views of Gulf International Forum.