Now is the time for OPEC+ to break its “pre-emptive” response rule

Crude prices not only shrugged off the September 5 decision by eight members of the OPEC/non-OPEC alliance to postpone the unwinding of their combined cuts of 2.2 million b/d by two months to a December 1 start, but actually went on to dive lower.

Front-month (November) Brent futures settled at a three-year low of US$71.06 on September 6, continuing to be battered by fears of a US recession and a panic sell-off across risk assets, a theme that has dominated the broader financial markets since the beginning of August.

The latest wave of risk-aversion came in the wake of sub-optimal US employment data for August, which perpetuated market concerns over a weakening job market and doubts over the US Federal Reserve’s ability to come up with an adequate policy response to avert a sharp slowdown in the country’s economy, or even a recession.

The June 2 decision by the OPEC+ “Group of 8” to gradually phase out their “voluntary” cuts over October 2024 to September 2025 had taken the oil market by surprise and exerted immediate downward pressure on crude. That became water under the bridge as prices rebounded through July amid a drumbeat of summer “demand bump” expectations, especially for gasoline and jet fuel, on the back of holiday travel and peak US driving season.

But as crude came under relentless pressure from a rapidly deteriorating global oil demand outlook and growing pessimism over the US economy starting in August and continuing into September, the spotlight naturally returned to the OPEC+ G8’s decision that would have put about 180,000 b/d of additional supply into the market per month from October 1.

The focus on OPEC+’s response was sharpened by comments after the June 2 tapering decision from some of the G8 energy ministers, including Saudi Energy Minister Abdulaziz bin Salman, that the producers stood ready to pause or even deepen the cuts, should circumstances demand it.

OPEC+ members officially disavow crude price targets but the consensus view in the market has been that they would seek to defend a $70 floor for Brent.

As crude prices threatened to crash through that psychological level, the G8 likely felt the pressure to respond with a supply-tightening measure. The decision to defer the tapering could not have been easy but in addition to trying to avert a freefall in crude, it was also a matter of walking the talk.

The move also aligned with OPEC+’s mantra of recent years, repeatedly articulated by the Saudi energy minister, to be “pre-emptive” and “pro-active” in responding to global oil supply-demand imbalances for a more effective strategy of maintaining equilibrium in the physical market.

But now is probably the time for OPEC+ to make an exception to that rule.

There are important lessons to be drawn from the market brushing away the two-month extension of the cuts, including the fact that the “compensatory” reductions pledged by Iraq, Russia and Kazakhstan for their quota-busting over the first seven months of the year actually lowers the overall G8 output target by about 360,000 b/d in October and 132,000 b/d in November compared with the first half of the year.

Some might argue that a mere two-month prolonging of the cuts was not enough to counter the strong headwinds of economic and demand slowdown worries blowing crude’s way. Some might say the market has begun to discount OPEC+’s ability to continue the restraints for much longer, especially as the incremental cuts are inequitable. They are being borne by only eight of the 18 members bound by quotas, who are having to lock away spare production capacity even as competitors – prominently the US, Canada, Brazil and new producer Guyana – snatch market share.

None of these assertions are wrong. But they miss out vital elements of the full picture.

The harsh realities of the current situation is that expectations over the US economy and the Fed’s ability to engineer a “soft landing” are in a major flux. Fears, interlaced with panic and paranoia over a looming recession in the world’s largest economy, have become par for the course. The frenzied downgrading of short- and medium-term oil demand projections is often akin to throwing darts in the dark.

So, what lies ahead? A Fed policy pivot at its September 17-18 is baked in. But the market is particularly anxious over whether the US central bank’s maiden cut after two and a half years of tightening will be a conservative 25 basis points or a bolder 50 bps. Paradoxically, both are equally capable of soothing or rattling the markets. The skittishness is unlikely to end there; traders can be expected to continue revising bets on the Fed’s easing trajectory in the coming months, leaving the financial markets vulnerable to violent swings between optimism and pessimism. Crude will be exposed to the volatility and also downward pressure if the mood remains downbeat.

Meanwhile, though the lacklustre oil appetite in China and Europe is not in doubt, in all probability, the US economic uncertainty is amplifying the gloom-and-doom scenario and the bearishness on crude, potentially causing miscalculations that might only become clear in hindsight.

OPEC+ would do well to wait out this storm of uncertainty for a clearer picture of demand as well as the US economic trajectory, which might begin to emerge early next year. When the price signals are this flighty and confounding, it’s best to temporarily put aside the principles of pro-active and pre-emptive action and nimble responses.