GP Short Notes

GP Short Notes # 674, 9 October 2022

OPEC: The curious case of OPEC's production cuts
Bhoomika Sesharaj

What happened?
On 5 October, the 13 members of the Organisation of Petrol Exporting Countries (OPEC) and 10 allies of the group forming the OPEC+, which includes Russia, met in Vienna to drop oil production quantities by two million barrels per day (bpd). Producing about 30 per cent of the world’s crude oil, this decision comes as the world grapples with an undersupply of oil by 1 million barrels per day and creates a tight supply of oil to the West which is already sifting through an energy crisis. 
 
“A recession is one of the challenges we are looking at. We all know a recession affects supply and demand,” UAE’s Energy Minister Mazrouei said, and said that economic stressors were the key reason why the agency decided to cut production. The oil quota reduction came as a surprise to the West as they warned the organisation against such drastic measures, but the meeting offered no resolve to countries like the US, the UK, and the EU. 
 
The OPEC defended its stance to say that the cuts were not meant to pit one country against another, but was a “pre-emptive measure”. Citing that the move was necessary, the decision was met with criticism by the US which said that OPEC was "aligning” with Russia. This decision was also considered a blow to the European Union, as sanctions on Russian crude oil and oil production are set to take effect starting in December. This said that OPEC+ does not target pricing but strikes “a balance in supply and demand.”

What is the background?
First, the evolution of the organization. The OPEC is a permanent, intergovernmental organisation created at the Baghdad Conference in 1960, and was initially a five-member organisation, including Iraq, Kuwait, Saudi Arabia and Venezuela. Later joined by eight others, and other non-OPEC allies, the OPEC was formed to stabilise oil pricing and strengthen oil production in the global market.  The OPEC sees prominence in the control of domestic petroleum, and battled excessive volatility in the 1980s and 1990s, with the Southeast Asian economic downturn and economic recession. The OPEC strives to string a well-oiled supply of crude oil to the market and has developed as an essential organisation over the years. The OPEC, however, has a history of battling with the West regarding its pricing and oil policies. 
 
Second, significance of the recent decision to reduce production. OPEC nations, along with Russia, produce over 10 million barrels per day and add a great deal to the demand and supply of the global market. The OPEC deals strongly with the US dollar, as oil production and crude oil are dominated by the currency. OPEC’s decision to cut output by 2 million barrels per day comes at a time when the global market seeks saving from inflationary rises and high pricing, leading to an extensive dependency on short-term energy services. 
 
Third, implications for the US. The US is grappling with soaring interest rates and President Joe Biden’s campaign for mid-term elections long-standing assurance of capping oil prices. The refinery issues plague the West coast and Midwest putting the US in a considerably stiff position, where the US already sees an undersupply of oil. The country’s dependence on Strategic Petroleum Reserves (SPRs) leads to a concerted decline in its overall reserves and leaves a depleting graph for the US to work with.  
 
Fourth, implications for Russia. Russia seeks to increase prices while maintaining a balanced output as it already produces over 9.9 million barrels per day, short of its 11 million barrels per day. The undersupply sees a larger output for Russia to work with, with sanctions on the country coming to effect later this year. The country is speculated to side with Saudi Arabia against the US, the New York Times reported. This move could mean the alignment of the two against the West’s concerted efforts to restrict Russian oil. 
 
Fifth, implications for the global market. OPEC’s move highlights the increasing rates of inflation, consumer prices and intensive political tensions as the EU’s position in the global economy recedes with the quick transitory trends of the energy sector. The reduction in oil would create divisions between EU leaders over capping oil prices and fighting over the lack of fuel. The decision comes as a forecasting warning to the energy security crisis that the EU could face in the winter, and lead to a larger economic problem of juggling between consumption, saving and selling of oil. This comes as a shock to India as well, with the freezing price of petrol and diesel seeing a potential rise, with producers forgoing their previous small profits of INR 5 before the decision came out. The underlying realisation of this decision lies at the overall scenario of the world economy as it strikes against unsustainable energy budgets, implications of a stronger dollar, and the economic risks of selling assets.

What does it mean?
For the US, the cut could lead to a reproaching of a kind, with the US seeking Venezuela and Iran out of its ‘pariah’ state and looking for sustainable options to produce its own domestic oil. For Russia, there is no reduction in output as part of the production cut decision by OPEC, rather it sees a slight balance in its reach. For the global market, the decision would incite a lower energy demand in the long term, with consumers seeking less energy-consuming services in the future.

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