How will OPEC+ cuts affect oil prices and inflation?

FRANKFORT, GERMANY — Major oil-producing countries, led by Saudi Arabia and Russia, have decided to drastically reduce the amount of oil they deliver to the world economy.

And the law of supply and demand suggests that can only mean one thing: higher prices are on the way for crude oil and for diesel fuel, gasoline and heating oil that are made from oil.

The OPEC+ alliance’s decision to cut 2 million barrels a day from next month comes as Western allies try to limit the oil money flowing into Moscow’s war chest after it invaded Ukraine.

Here’s what you should know about OPEC+’s decision and what it could mean for the economy and the oil price cap:

Saudi Arabian Energy Minister Abdulaziz bin Salman says the alliance is being proactive in adjusting supply ahead of a potential drop in demand because a slowing global economy needs less fuel for travel and industry.

“We are going through a period of various uncertainties that could come our way, it is a cloud that is brewing,” he said, and OPEC+ sought to stay “ahead”. She described the group’s role as “a moderating force, to bring about stability.”

Oil prices have fallen after a summer of highs. International benchmark Brent crude is down 24% since mid-June, when it traded above $123 a barrel. Now it is at $93.50.

One of the main reasons for the drop is fears that much of the world economy is slipping into recession as high energy prices (oil, natural gas and electricity) drive inflation and deprive consumers of power. purchasing.

Another reason: The summer highs came on fears that much of Russia’s oil production would be lost to the market because of the war in Ukraine.

As Western traders rejected Russian oil even without sanctions, customers in India and China bought those barrels at a deep discount, so the hit to supply was not as severe as expected.

Oil producers are wary of a sudden collapse in prices if the global economy falls faster than expected. That is what happened during the COVID-19 pandemic in 2020 and during the global financial crisis in 2008-2009.

The United States and Britain imposed bans that were mostly symbolic because neither country imported much oil from Russia. The White House has refrained from pressing the European Union to ban imports because EU countries get a quarter of their oil from Russia.

In the end, the 27-nation bloc decided to cut off Russian oil arriving by ship on December 5, keeping a small amount of pipeline supplies that some Eastern European countries depend on.

Beyond that, the US and other major democracies in the Group of Seven are working out the details of a price cap on Russian oil. It would target insurers and other service providers that facilitate shipments of oil from Russia to other countries. The EU approved this week a measure in this sense.

Many of those suppliers are based in Europe and would not be able to deal with Russian oil if the price is above the limit.

The idea behind the price cap is to keep Russian oil flowing to the global market, only at lower prices. Russia, however, has threatened to simply stop deliveries to a country or companies that observe the cap. That could drive more Russian oil off the market and drive up prices.

That could also increase costs at the pump.

US gasoline prices, which hit an all-time high of $5.02 a gallon in mid-June, had recently been falling but have risen again, posing political problems for President Joe Biden a month before the elections. mid-term elections.

Biden, facing inflation near 40-year highs, had touted falling pump prices. Over the past week, the national average price per gallon rose 9 cents to $3.87. That’s 65 cents more than what Americans were paying a year ago.

“It is a disappointment and we are seeing what alternatives we can have,” he told reporters of the OPEC+ decision.

Probably yes. Brent crude should hit $100 a barrel in December, says Jorge Leon, senior vice president at Rystad Energy. That’s up from an earlier prediction of $89.

Part of the 2 million barrels per day cut is only on paper as some OPEC+ countries are unable to produce their quota. So the group can deliver only about 1.2 million barrels a day in actual cuts.

That will still have a “significant” effect on prices, Leon said.

“Higher oil prices will inevitably add to the inflation headache that global central banks are fighting, and higher oil prices will factor in the calculus of raising interest rates further to cool the economy,” he wrote. in a note.

That would exacerbate an energy crisis in Europe tied largely to Russian cutbacks in the supply of natural gas used for heating, electricity and in factories, and drive up gasoline prices around the world. Since that fuels inflation, people have less money to spend on other things like food and rent.

Other factors could also affect oil prices, including the depth of any potential recession in the US or Europe and the length of China’s COVID-19 restrictions, which have dented demand for the fuel.

Analysts say Russia, the largest producer among the alliance’s non-OPEC members, would benefit from higher oil prices ahead of a price cap. If Russia has to sell oil at a discount, at least the reduction starts at a higher price level.

High oil prices earlier this year made up for much of Russia’s lost sales as Western buyers shunned its supply. The country has also managed to divert around two-thirds of its typical Western sales to customers in places like India.

But then Moscow saw its oil take fall from $21 billion in June to $19 billion in July to $17.7 billion in August as prices and sales volumes fell, according to the International Energy Agency. . A third of Russia’s state budget comes from oil and gas revenues, so price caps would further erode a key source of revenue.

Meanwhile, the rest of Russia’s economy is contracting due to sanctions and the withdrawal of foreign companies and investors.

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