OPEC+ Production Cuts Show Energy Security Has a Price

The Organization of the Petroleum Exporting Countries and its allies on 5 October announced plans to reduce oil-production quotas by 2 million barrels a day (b/d) starting in November. The realized output cut is expected to be closer to 1 million b/d, given most member nations are already producing below quota levels.

We view this move as supportive for energy prices, as commercial inventories are currently below average and would have been at historic lows if not for global strategic petroleum reserve releases. This action stands also to exacerbate global inflation, complicating the efforts of central bankers.

For investors aiming to hedge these inflation concerns or capitalize on a potential rebound in energy prices, commodity indices offer a compelling opportunity, particularly given the historically high positive carry (forward prices are lower than spot) in the main commodity indices. Further, the North American energy patch stands to be a primary beneficiary of the OPEC+ plan.

OPEC+ reasons are many and signal is clear

OPEC+ argued that the move was preemptive to avert price weakness in case the Federal Reserve’s policy tightening to rein in inflation leads to a demand slowdown. Another reason offered was that the world is underinvesting in upstream oil and gas, so supporting prices in the face of economic weakness will serve the long-term economic interests of everyone. With global upstream investment on a real basis roughly 25% below 2018-2019 levels, there certainly is merit to supporting higher investments.

While not directly stated, we wouldn’t be surprised if rebuilding spare capacity in key OPEC states – which is near historic lows – to provide a buffer for future supply outages was also a factor in the decision. In addition, it is hard not to wonder if the proposed price cap on Russian oil by the Group of Seven (G-7) nations was an unsettling precedent for other key oil producers, which have elected solidarity with Russia at the potential ire of global consumers.