Taps Coogan – April 3rd, 2023

OPEC’s announcement on Sunday of an additional 1.16 million barrels per day (bpd) of production cuts, on top of the 2 million bpd announced in October, and Russia’s parallel announcement that they would extended their 500,000 bpd production cut through the end of the year, has reportedly ‘surprised’ the market and sent oil prices higher. While it is true that the timing of the announcement is surprising – it comes before OPEC’s scheduled meeting and without the typical pre-announcement hints – the cut itself should not be a surprise.

Why?

To quote the article we wrote all the way back in October about the Russian oil ‘Price-Cap’ scheme:

Let’s imagine that the plan works and Russia chooses to keep selling oil. What would that mean?

It would mean that people could legally buy all the oil that Russia could sell at a guaranteed discount to the market price.

How do you think Saudi Arabia and the rest of OPEC will feel about having to compete with unrestricted volumes of legal Russian oil that sells at a guaranteed discount to market prices?

…

Not only will the price-cap plan incentivize sanctions evaders to ask for discounts on Russians oil, it will incentivize everyone to ask for discounts on all oil.

A $60 Russian oil price cap (or whatever the price cap is) would pull the whole market pricing towards that price as Saudi Arabia’s customers start demanding discounts to not switch to Russian crude.

Guess what happened? Oil prices fell to $65 a barrel within a three months of the $60 price-cap being implemented.

We further noted in that article from October:

Guess why OPEC was created? To avoid exactly such a market share fight among producers.

The Russian oil price cap deal is a direct and existential threat to OPEC and, as such, turns OPEC into an ally of Russia. It becomes imperative for all of OPEC, not just Russia, that the price cap scheme fails.

So what is the natural response of OPEC going to be to an attempt to kick off a price war via the threat of sanctions on an oil exporter? Obviously the response is to do exactly what OPEC announced Wednesday: dramatically reduce oil production and support prices.

Yours truly has no clue if the price jump seen in crude prices after yesterday’s announcement will stick. After all, you can still go buy Russian crude at discounts (assuming there is spare supply at those prices). However, we do know that as long as the price-cap scheme remains in effect, the aforementioned dynamics will prevail and production cuts will keep piling up. At some point they will ‘work.’