The OPEC+ oil plan for 2023 brings new inflationary risks

The OPEC+ oil cartel has a plan for 2023 – and, for now at least, it involves doing absolutely nothing. Having spoken to multiple officials during a Middle East trip last week, the words I heard most often were "stay put," followed by "wait and see."

The group, led by Saudi Arabia and Russia, feels vindicated about its cautious approach. In October, weeks before the US mid-term elections, it cut production, triggering a political onslaught from Washington. Despite the cut, Brent crude, the global oil benchmark, declined to $75 a barrel from $95 during the final quarter of last year due to weak Chinese demand and strong oil exports from sanctioned Russia and Iran. For OPEC+ officials, the 20% drop is a validation of its guarded attitude. If that prudent strategy paid off last year, it should work again in 2023, the thinking goes.

It's tempting to think that what did the job in 2022 will work again this year. But OPEC+ is taking a gamble: If the group gets its supply and demand calculations wrong, it risks inflicting higher energy prices on a world still fighting elevated inflation. Already, Brent prices have recovered from the December lows. After Russia last week announced it was cutting its oil production by 5% — or about 500,000 barrels a day — in response to Western sanctions, prices rose to just above $85 a barrel.

Weaker oil

Despite an OPEC+ production cut announced in October, oil prices have struggled in recent months, trading well below the $100-a-barrel level.

Infograph: Bloomberg

Still, OPEC+ would rather err on adding too few barrels than too many, at least for the first half of the year, and likely all of 2023. As an immediate step, the group has decided against backfilling the Russian cut. Middle East officials point out that there's plenty of precedent for an OPEC+ nation acting unilaterally: Saudi Arabia, the United Arab Emirates and Kuwait cut production alone in June 2020, and Riyadh delivered a solo reduction again in February 2021. Russia has a corresponding right to act, its oil allies say. Western oil sanctions are universally detested within OPEC+.

If the consequence of the cautious approach is that oil prices rise further later this year, perhaps toward the $90-to-$100 a barrel level, that's an outcome the group appears to be happy with. The priority, particularly in Saudi Arabia, is to protect oil revenue. That means putting the kingdom first, and everything else second. The guarded strategy matters beyond the oil market. If the cartel falls behind the demand curve, it could mean higher energy prices than expected, wrong-footing inflation-fighting central banks. That, in turn, could mean higher interest rates, spilling over everything from bonds to equities to real estate.

Would OPEC+ really stay on hold for the whole year? For now, it's easy for officials to say they would keep output flat for months to come. Brent crude at $85 a barrel hasn't triggered any complaints from consuming nations. But the pressure on the group would escalate if oil prices climb above $90 a barrel. Another 10% on top, putting Brent close to $100, would trigger alarm in the US and Europe. 

In private, OPEC+ officials do acknowledge the global economy is in better shape than four months ago, when they cut production in the face of an anticipated drop in demand. The International Monetary Fund is predicting now a 2.9% expansion this year, compared to a forecast of 2.7% in October. Inflation also appears to have peaked, and central banks are becoming more confident they'll be able to achieve a so-called soft landing.

China is reopening fast, which no one was predicting four months ago. Nearly 1.1 million people rode the Beijing subway last week, the highest in more than a year. Middle East national oil companies are starting to see higher demand from China too, officials say. Still, many remain worried about further setbacks, noting that China has endured several cycles of lockdowns followed by relaxation followed by further lockdowns since Covid first hit.

Back to the office

Subway use in Beijing has risen to a one-year high in early February, approaching the peak values seen in the post-covid era in 2020 and 2021.

Infograph: Bloomberg

The physical oil market is also showing the first signs of recovery. For example, in early February, Saudi Aramco, the state-owned oil giant, hiked its official selling prices for Asia for the first time in six months. The slope of the oil-price curve also indicates a strengthening market, with nearby oil contracts now trading at a bigger premium to contracts for later delivery than four months ago.  At about 60 cents a barrel, the second-to-third front month Brent crude spread is at its widest in three months.

But OPEC+ officials aren't convinced they can relax yet. Even after the Russian output cuts, oil inventories are still likely to climb over the next few months before the trend reverses in the second half of the year, they say. On current OPEC calculations, global oil inventories will only decline sharply in the fourth quarter, when demand for oil will climb to 30.4 million barrels a day compared with current daily output of 28.9 million barrels. That's one reason why they would like to see a sustained recovery in China, over several months. They would also welcome evidence that central banks are slowing, or even pausing, their interest-rate hikes.

Bottom of form

The next OPEC+ ministerial meeting is scheduled for early June. Would the cartel have enough data by then to hike production if oil prices continue climbing? What I heard in the Middle East was a resounding no. For now, regional oil officials would like to wait until, at least, the third quarter before acting. That, in turn, means that any extra oil would only arrive by year-end. Some officials rule out any output hikes at all in 2023.

OPEC+ officials are right to argue that they read the market correctly in October. But past performance doesn't guarantee future returns. The cartel risks falling behind the curve in 2023.