Trump dealt a blow as the world is flooded with oil

3 months ago 22

OPEC+’s two-year strategy to push up global oil prices will have been unwound next month after the cartel decided on another big return of latent production capacity to the market.

At the weekend, the Saudi-led cartel agreed to add back 547,000 barrels a day next month, after lifting production by 548,000 barrels a day this month.

President Donald Trump with Saudi Crown Prince Mohammed bin Salman in May. The Saudi-led oil cartel is ramping up production.

A strategy that OPEC+ embarked on in April, which was supposed to return about 2.2 million barrels a day to the market over 18 months, will be completed a year early.

The 2.2 million barrels a day of production cuts was supposed to put a rising floor under oil prices but widespread non-compliance with quotas within the cartel, the slowdown in China’s economy and increased production from non-OPEC producers like the US, Brazil, Canada and Guyana undermined the OPEC+ effort.

Maintaining the caps on output made increasingly less sense when key members were blatantly ignoring their commitments while gifting market share to non-OPEC+ producers by maintaining a failed attempt to choke supply has involved massive opportunity costs for the cartel members.

Having accepted reality, OPEC+ is now opening the spigots.

While unlikely in the near term, there is a lot of capacity for it to do even more. In their entirety, the capacity withdrawn from the market over nearly a decade totalled about 6 million barrels a day.

There’s another 3.85 million barrels on the sidelines, including 1.66 million barrels a day that is supposed to be returned to the market at the end of next year and whose fate may be debated by OPEC+ later this year.

Even without that next tranche of capacity, OPEC+’s increase in output this year will hit a market that is expected to be over-supplied by as much as 2 million barrels a day in the fourth quarter of this year

The current Brent oil price is about $US68 a barrel but analysts from major banks like JPMorgan Chase and Goldman Sachs have forecast oil prices of around $US60 a barrel by the end of the year.

The shift in OPEC+ strategy could be regarded as self-destructive. The key Middle Eastern producers have very low production costs (the Saudi’s are less than $US15 a barrel) but need prices ranging from about $US65 a barrel (United Arab Emirates) to $US80 to $US85 a barrel (Saudi Arabia) to balance their budgets. Flooding the market with more oil will almost inevitably push prices down.

Having accepted reality, however, the cartel is now trying, again, to implement a strategy it has attempted twice before – first between 2014 and 2016 and then in 2020 – where it tried to take market share away from the US shale producers by driving the price below their production costs.

It underestimated the dynamic nature of the shale producers who, after an initial drop in their production, cut their costs and increased their productivity at a startling rate.

Will OPEC+ be any more successful this time?

The US producers are more returns-focused than they were during those earlier episodes and, with some of the major basins’ reserves depleting, more likely to respond to a lower oil price by mothballing their wells. Already, with West Texas Intermediate prices around $US66 a barrel, there are about 46 fewer rigs operating onshore in the US than there were a year ago.

Trump might want the US companies to “drill, baby, drill,” but a recent Dallas Federal Reserve Bank survey showed most would reduce their drilling if the US price fell towards $US60 a barrel. Breakeven costs for US producers average around the mid-$US60 dollars a barrel.

There could be something of a safety valve for both the core OPEC producers and the US shale oil sector.

This Friday is the deadline Trump has set for Russia to agree a ceasefire in Ukraine, with Trump threatening secondary tariffs of 100 per cent on Russia’s oil customers if it doesn’t comply. India which, with China and Turkey, has been one of the major buyers of Russian oil during the conflict, has been specifically targeted by Trump.

Russia’s new production target will be 9.45 million barrels a day next month. Any material reduction its oil sales would create space for the increased production of other OPEC+ members and take some of the pressure off oil prices.

Trump wants the US companies to “drill, baby, drill,” but a recent Dallas Federal Reserve Bank survey showed most would reduce their drilling if the US price fell towards $US60 a barrel.

Absent the withdrawal of Russian supply, even if Russia is eventually able to find a workaround (as it has throughout the war in Ukraine and the sanctions regime the G7 has imposed), the outlook for demand in the near term isn’t great.

China’s economy has been spluttering and is further threatened by Trump’s trade wars. The US economy has weakened sharply because of, initially, the uncertainty Trump’s trade and immigration policies and his assault on government agencies have created and now the reality and increasing economic impacts of his tariffs.

The global economy will slow as a result of Trump’s assault on global trade. Some of the faster-growing economies, and those most dependent on imported energy – the Asian, South American and African developing economies – are, perversely, among those facing the most punitive tariffs.

Having accepted reality, OPEC+ is now opening the spigots.

While lower oil prices might help keep a lid on inflation rates, particularly the US inflation rate, and provide some offset for those import-dependent economies from the effects of Trump’s tariffs, the trade-off will be reduced economic growth.

The longer-term outlook for oil is clouded.

OPEC believes demand, fuelled by developing economies, will continue to grow through to 2050, rising from just over 100 million barrels a day to 123 million barrels a day. The International Energy Agency believes demand, impacted by electric vehicles and electrification more widely, will peak at about 105 million barrels a day in 2030.

While the long-term outcome matters for the members of the cartel, who are still overly reliant on oil revenue despite increasingly urgent attempts to diversify their economies, it’s the near term outlook for oil prices that matters for an increasingly messy and threatened global economy.

It also matters for Trump’s economic strategy, as articulated by his Treasury Secretary, Scott Bessent.

Bessent’s “3-3-3” strategy has three major components. He aims to reduce the federal deficit to 3 per cent of gross domestic product, raise GDP growth to 3 per cent per year and add 3 million barrels per day of domestic oil production.

Thanks to Trump’s “One Big Beautiful Bill,” which could increase US deficits by about $US3.4 trillion over the next decade, the impact of his tariffs on US inflation and growth (already running at less than half the rate achieved last year) and OPEC+’s flooding of the market with increased oil supply, each of those objectives (which never looked likely or added up to a coherent strategy) now seem wildly unrealistic.

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