Geopolitical implications of the OPEC+ oil production cut

OPEC+, the Saudi Arabia-led oil producers’ group that includes the 13 OPEC member countries and Russia, announced surprise oil production cuts on 2 April 2023.

The cuts will take effect next month and will reduce the supply of crude oil by over 1.1 million barrels per day (bpd), on top of existing cuts of 2 million bpd agreed on in October 2022. The move also comes on the back of Russia’s decision to maintain its ongoing production cut of 500,000 bpd for the rest of 2023.

The OPEC+ announcement saw global oil prices jump by more than 7 percent, with the cost of a barrel of Brent crude rising to almost $86. Prices are now expected to continue upwards, with Goldman Sachs lifting its forecast for Brent to $95 a barrel by end of the year and to $100 for 2024.

There are both economic and geopolitical drivers behind the announced reduction. OPEC+ representatives reported that the cuts are “a precautionary measure aimed at supporting the stability of the oil market”. Saudi Arabia appears determined to defend a higher price floor – Brent prices had dipped towards $70 a barrel in mid-March.

Saudi Arabia relies on high oil revenues to fund its ambitious expansion schemes, and efforts to diversify the kingdom’s economy. The nation earns 80 percent of its export income from oil, which makes up around 40 percent of gross domestic product.

The outlook for this revenue is expected to be negatively impacted by global decarbonisation policies – a 2020 report from the Brookings Institute stated that “in the medium term, revenues from oil [in the Gulf] are expected to decline in the face of reductions in global demand starting around 2040, if not sooner”.

Riyadh’s position as the leader of OPEC gives Saudi Arabia geopolitical influence over other regional oil producers, particularly the United Arab Emirates (UAE). Both are competing for influence in global oil markets. The cuts force the UAE to pump much less oil than it is capable of, hurting revenue.

The UAE publicly supported last year’s oil reduction but privately said they wanted to increase production. Emirati officials reportedly signalled that the UAE is considering leaving OPEC, due to tensions with Saudi Arabia. Yet the recent cuts – and UAE’s lack of official dissent – indicate cohesion remains robust, for now.

Perhaps the most compelling aspect of the production cuts is what they say about the balance of power in the Middle East. The moves point to cooling relations between the US and Saudi Arabia and a warming of Riyadh’s links with Russia and China.

The US has responded with muted frustration. John Kirby, a spokesperson for the US National Security Council said the US doesn’t “think cuts are advisable at this moment given market uncertainty – and we’ve made that clear”. Last year, President Biden made a special appeal to Saudi Crown Prince Mohammed bin Salman to increase oil production, only to have producers cut their output in OPEC's October meeting.  

In sitting down with the Crown Prince, Biden reversed his policy of shunning the kingdom’s de facto leader, in the hope of securing increased production. OPEC’s recent move signals Saudi inclinations to pursue national interests, despite the Biden administration’s vocal opposition. The US loss of influence in the region is compounded by China’s growing presence, as seen in Beijing’s brokering of a rapprochement between Saudi Arabia and Iran, and Riyadh’s recent accession to the role of dialogue partner at the Shanghai Cooperation Organisation.

In terms of Russia, OPEC’s production cuts on top of Moscow’s existing 500,000 bpd reduction is of particular note. Russia and Saudi Arabia appear to be acting in unison, or at least pursuing complementary goals. Reduced global supply will provide a significant economic boost to Moscow and help the government withstand Western sanctions in the short term.

Russia is currently contending with declining oil revenues and an increasing budget deficit. Moscow earned $11.6 billion from oil exports in February, down from $14.3 billion in January and a 42 percent drop from $20 billion earned in February 2022. Whilst shipments of Russian oil to European Union countries have fallen, Moscow has managed to reroute most of their oil – mainly to India and China, but also to Asia, Africa and the Middle East.

In other impacts, the surprise move by OPEC+ will place pressure on Western efforts to curb inflation and cost of living pressures. Although Western economies are less oil-intensive than when OPEC was created in 1960, higher oil prices have complex impacts. Manufacturing and transport will become more expensive, and this inflation will make consumers less willing to spend.

While governments and central banks had been expecting inflation to fall this year, the move threatens to derail their predictions. Higher oil prices will put central banks such as the Federal Reserve, the Bank of England and the European Central Bank on alert, and could build the case for further interest rate hikes.

The impacts in Australia will include these inflationary pressures, plus some potential upside for certain sectors. The jump in energy prices will likely boost the profits of Australian oil and gas producers. The Albanese government was already considering a tax rise on the soaring profits of gas companies, and tightening up the petroleum resource rent tax. Rising oil prices could prompt Labor to act as soon as the May federal budget, with the proposed tax expected to help subsidise the $3 billion of joint Commonwealth state assistance for household energy bills.

Stepping back, Australian stakeholders would be wise to consider what these production moves represent. As the world decarbonises, the potency of OPEC+’s near-oligopoly will begin to wane. Until then, we may see more instances of global oil output being managed for geopolitical leverage, creating impacts on every industry that relies on energy or transport.