Oil’s OPEC+ Plus Sign Isn’t Assured to Last

Move over, banks—it seems like a new hot topic is in town. After OPEC and its partners (known as OPEC+) announced a surprise production quota cut Sunday, crude jumped on Monday, refueling (sorry) inflation fears. The “biggest one-day jump since March 2022” got heaps of attention. Less noticed? The fact that even with Monday’s price movement, crude prices remain below levels seen at this point last month—and well off last year’s highs.^[i] Couple that with OPEC quotas’ overall feckless recent history, and we are hard pressed to see what all the fuss is about. This seems much more like an early bull market scare story than a fundamental reason for stocks to tumble to new lows from here.

When OPEC+ nations get together, they theoretically assess global demand, production in the US and other non-cartel nations, and then set production targets at a level they anticipate will balance supply and demand. In October, they made waves by announcing “voluntary” cuts that would reduce production by 2 million barrels per day (bpd) beginning in November and lasting through 2023. Prices bounced higher initially … then fell. Sunday’s announcement added another voluntary 1.66 million bpd reduction, which includes Russia’s plans to cut output by 500,000 bpd in the face of tighter Western sanctions. OPEC+’s announcement states these cuts are “aimed at supporting the stability of the oil market.” But most coverage couched this as the cartel piling production cuts on top of production cuts in an attempt to boost crude prices. That rhetoric, coupled with Brent crude’s nearly $5 jump on Monday, resurrected inflation fears.

In our view, this is all a bit hasty. For one, even with Monday’s jump, crude is down significantly from 2022. Heck, prices closed Monday well below their spike after October’s production cut announcement. Then, Brent crude temporarily flirted with $100 per barrel before falling in November and December. It closed Monday around $85, in line with prices throughout December, January and February.^[ii] If energy prices then were disinflationary, we don’t see why they would suddenly be some massive consumer price booster now.

Exhibit 1: Oil Is Still Down

Source: FactSet, as of 4/4/2023.

Maybe oil soars from here, but we rather doubt it. There is a pretty solid history of OPEC+ making big announcements, markets reacting one way immediately, then reverting to extant trends as global supply and demand come back into focus. On that front, OPEC+’s quotas aren’t as meaningful as advertised. For one, the US and other non-members produce the majority of global crude, diminishing OPEC+’s power over supply. Production in the US, Brazil and elsewhere continues rising, and most forecasts see global supply rising this year despite OPEC+’s machinations.

Two, the cartel and its partners haven’t exactly hit their quotas to begin with. October’s cuts put the production target at about 41.36 million bpd for November onward. In October, the participants’ collective output was 38.47 million bpd.^[iii] It inched a tad lower in November to 38.8 million bpd and slipped again to 37.68 million bpd in December.^[iv] But it crept back up to 38.05 million bpd in January and 38.1 million bpd in February.^[v] Overall, the drop is nowhere close to 2 million bpd. The only thing that has changed is that because the quota is lower, the minimally changed output undershoots the target by a smaller amount. The gap between output and the quotas simply narrowed from 3.63 million bpd in October to just over 2 million in February.^[vi] Cutting the target again just brings it even closer to where actual output is.

Accordingly, it seems rather unlikely OPEC+’s move causes inflation to rocket higher from here. Even slightly higher fuel prices in the immediate future would be down big from their year-ago comparison points, making them a deflationary CPI component. Meanwhile, businesses have already swallowed last year’s energy cost increases, factored them into their costs and sales prices, and moved on. Fisher Investments Founder and Executive Chairman Ken Fisher often likens last year’s inflation to a large rodent that a snake ate and then digested slowly—picture a lump slowly pulsing through. It took a while, but by this point, most of last year’s big inflation drivers have worked their way through the system, and eased tremendously. Energy is down. Shipping conditions and costs have eased. Supply shortages are evening out. Money supply is slowing or even falling, depending on the measure you use.

Investors have a long history of fighting the last war. In the early 2010s, many were on high alert for a new financial crisis—still are, as last month suggests. In 2020 and 2021, people were on watch for new lockdowns roiling economies. Now an inflation repeat seems front of mind. This is a sign of sentiment, and it is what we would expect to see in a young bull market—it is a big part of what builds the wall of worry. The more people look high and low for signs of resurgent inflation—sapping its surprise power—the more this looks like a new bull market.

Hat tips: Fisher Investments Research Analysts Larissa Murray and Ori Powers