What had happened last week?
OPEC Announces Surprise Oil Production Cut
Oil prices surged after the Organization of the Petroleum Exporting Countries (OPEC) announced a surprise production cut of more than a million barrels a day. The decision was led by Saudi Arabia with the aim of bringing pricing stability to the oil market. This move angered the western economies as all of them are still struggling to contain inflation. Just when the inflationary pressure is easing, it seems that the surprise decision will add on to positive inflationary pressure going forward. I am not sure if FED will take this new development as a factor for consideration in their next rate hike decision. But market has certainly react to it as crude oil shot above US$80 per barrel once again. Many commodity analysts have started to upgrade the target price of oil for the rest of the year as well.
Why cut?
The move is perceived to be a defensive one from the oil cartel to account for the possibility of a drop in oil demand as recession fear looms. Supply is reduced to at least maintain the price of oil for the rest of the year as demand is expected to fall. Oil prices had consistently fall after it hits US$120 per barrel last year and that drew concerns from the oil cartel.
What is the impact of this production cut?
The latest cut will bring total cuts to 3.66 million barrels per day, which is roughly 3.7% of global demand. Prices have moved up since the announcement with analysts upgrading target price of oil higher. Goldman Sachs analysts raised their Brent price forecasts for December 2023 up US$5 to US$95 per barrel and the Head of Investing at Pickering Energy Partners said the cut could lift oil prices by US$10 per barrel in the near term.
What this means to investors?
With the sudden announcement, it has caused a frenzy buying of oil, propelling the price of oil up 8% within a day. We see a bit of an euphoria here which is emotionally driven (not good for an investor to be driven by emotions). This move from OPEC was preemptively done to minimize the pricing effects of a possible downturn in oil demand. However, demand could come in lower than expected as a result of slowing global economy, which will see a retracement of the higher oil prices.
In the event that oil prices stay elevated, it will add on to inflationary pressure, making it hard for the central banks to make decision on monetary policies. Not only that, as oil price has a butterfly effect on the whole market, logistics costs and pump prices will negatively affect consumer spending.
On a personal note, I am not that rosy on oil price going forward, even with the OPEC cuts. With the interest rates elevated at this moment, and possible another 25 bps hike in next FED meeting, demand may come in lower that what the market is expecting. Prices of oil fell below US$80 a barrel for a reason, the possibility of a recession on the horizon. I believe this narrative has not changed. An additional point to note, based on past OPEC experiences, they only say that they will cut and in actual fact, each individual OPEC nations did not adhere to the amount of cuts agreed. Do also take note that the recent output cut is based on a voluntary basis. As such, I see the recent price of crude at above US$80 per barrel as toppish. I will be looking at taking short positions as it moves higher in the days or weeks to come.
Update (3rd of May 2023):
Covered my short position in oil. Shorted WTI crude at $82 per barrel. Just covered at $69.20 per barrel. Article was written on the 11th of April (dated on the article). Total return of 15.6% in one month, annualized return is 187%