The Breakdown - What OPEC+ Oil Cuts Mean for the Global Economy and Geopolitics

Episode Date: October 7, 2022

This episode is sponsored by Nexo.io, Circle and FTX US.   As inflation rages, the global economy slows, and the U.S. releases more and more oil from its Strategic Petroleum Reserve, OPEC+ has decided to decrease oil output. The move happens in spite of significant pressure from the Biden Administration. NLW discusses what it means for economic prospects as well as for shifting geopolitical alliances.  - Nexo Pro allows you to trade on the spot and futures markets with a 50% discount on fees. You always get the best possible prices from all the available liquidity sources and can earn interest or borrow funds as you wait for your next trade. Get started today on pro.nexo.io. - FTX US is the safe, regulated way to buy Bitcoin, ETH, SOL and other digital assets. Trade crypto with up to 85% lower fees than top competitors and trade ETH and SOL NFTs with no gas fees and subsidized gas on withdrawals. Sign up at FTX.US today. - I.D.E.A.S. 2022 by CoinDesk facilitates capital flow and market growth by connecting the digital economy with traditional finance through the presenter’s mainstage, capital allocation meeting rooms and sponsor expo floor. Use code BREAKDOWN20 for 20% off the General Pass. Learn more and register at coindesk.com/ideas. - “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. Music behind our sponsors today is “The Now” by Aaron Sprinkle and “The Life We Had” by Moments. Image credit: William_Potter/Getty Images, modified by CoinDesk. Join the discussion at discord.gg/VrKRrfKCz8.

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexo.io, Circle, and FtX, and produced and distributed by CoinDesk. What's going on, guys? It is Thursday, October 6th, and today we are talking OPEC. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the car. conversation. Come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. Also a disclosure as always. In addition to them being a sponsor of the show,

I also work with FTX. So, yesterday Dimitri Kofinas, the excellent host of Hidden Forces, retweeted a Bloomberg Middle East breaking story. The headline read, OPEC Plus panel proposes a cut of two million barrels a day to its output as they seek to halt the slide in oil prices. Demetri commented, OPEC basically just raised rates. So today we're getting into what he meant by that comment, what happened with oil yesterday, and what it means for the economy and geopolitics. Let's start with the barest bones of background. OPEC was formed in 1960 by Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela. The organization's goal is to coordinate oil production across nations to ensure that competition between oil-producing nations doesn't undercut pricing power.

Membership has fluctuated over the decades, including various Middle Eastern African and South American nations. Saudi Arabia serves as the leading member with Nigeria, the United Arab Emirates, and Iraq, being the other key members who have the means to vary production levels. In the early 2000s, agreement between the organization and those outside of it became more commonplace. In 2016, an accord was reached between 11 non-OPEC countries, including Russia and Mexico, and OPEC nations, to mutually reduce production. The alliance is referred to as OPEC Plus and led to several years of coordination. In the opening months of 2020, however, a rift opened up between Russia and OPEC as the global economy began slowing ahead of lockdowns. This ultimately culminated in OPEC officials presenting Russia with an ultimatum to slash their production to the tune of 1.5% of global supply.

Russia rejected this demand, effectively ending the alliance temporarily. OPEC functions by setting production quota caps which member nations are not allowed to exceed, limiting supply. OPEC is often pointed to as a textbook example of a cartel, an organization that exist purely to collude in markets and prop up prices. Forbes put it succinctly in an article released yesterday. Their objective is to maximize the value of oil they have in the ground. That objective is directly contrary to the desires of most U.S. politicians and consumers, which is access to cheap gasoline. The cartel-like behavior of OPEC has been seen by others as a necessity for the resource producing nations that constitute the group. Many of the members have very few exports other than oil,

making the price of oil and avoiding oversupply of the market an existential matter for the functioning of their economies. In the face of massive fiscal spending from Western countries since 2020 and COVID-19, some have made the case that resource-producing countries have a right to ensure that they aren't trading limited resources too cheaply for easily printed Western banknotes. Agree with this or not, it's been a common theme of recent speeches from Vladimir Putin and appears to be a theme that has struck accord with other resource exporters like OPEC and Brazil. So let's get into what has been happening with oil this year. Prices have ranged wildly. In the wake of Russia's invasion of you Ukraine, the price of oil surged, eventually peaking near $120 a barrel. This, of course, added even more

pressure to already surging inflation. Even before this, oil prices had been a major concern in the United States. Since last November, the Biden administration has been intervening in oil markets by selling barrels out of the Strategic Petroleum Reserve or SPR. In November, when oil prices approached $90 a barrel, the administration announced the release of 50 million barrels into the market over the following months to suppress a year-long ramping of prices in an effort to keep the economic recovery on track. In late March, this program was extended as energy markets came under pressure in the wake of the invasion of Ukraine. This second round of releases was much larger, 180 million barrels in total, and was in fact the largest SPR release in history. It was intended to, quote, serve as a bridge

until the end of the year when domestic production ramps up, according to a White House press release. However, U.S. production is up only 1.2% in the four months since March, and is not forecast to return to February 2020 levels until 2024. In September, the program, the program, was extended into November, but reports were that the White House was planning to announce the conclusion of the program in the coming weeks. Now the White House has reversed course, saying that the administration would release barrels, quote, as necessary. Now, when the Biden administration first contemplated SPR releases to curb high gas prices at the end of last year, the main critique was that the SPR was intended for emergency use rather than market intervention.

Whatever your position on that, as a result of the releases, the SPR now sits at its lowest level since July 1984. There are around 400,000. 16 million barrels remaining in the reserve. Now, given what happened this week with OPEC, one of the interesting curveballs, was a proposal from the White House to Treasury, which had been leaked to reporters this week. The proposal laid out that if OPEC had decided against a cut, the administration would announce a 200 million barrel purchase to refill the Strategic Petroleum Reserve. Essentially, they would be making up the difference for any shortfall in global demand that materialized in the next few months. According to a senior official, the U.S. had made it clear that we would be willing to

purchase OPEC oil to replenish the SPR. In other words, they aimed to convey that the U.S. wouldn't leave them hanging dry, their words, if OPEC countries invest in additional production ensuring that the global price of oil doesn't collapse in the face of an economic downturn. So that brings us to this week. Earlier on Wednesday, U.S. officials had made calls to allied Gulf state officials in an attempt to discourage production cuts. That, of course, is not what happened. preliminary White House talking points reported by CNN called the cuts a total disaster and said they could be viewed as a quote-unquote hostile act. The National Security Council went with a softer statement saying, we've been clear that energy supply should meet demand to support economic growth and lower prices for consumers around the world.

And we will continue to talk with our partners about that. However, U.S. officials speaking anonymously gave a glimpse into the mood within the administration. They said that the White House was, quote, having a spasm and panicking. And also that, quote, it's important everyone. is aware just how high the stakes are. Treasury Secretary Janet Yellen was reportedly asked to personally contact counterpart finance ministers to make the case that higher oil prices risk higher inflation and recession risk ultimately being counterproductive. The Biden administration was not happy about the announcement of the cuts. President Biden himself had visited Saudi Arabia in July to ask for

increased production and came away with an extremely modest short-term boost. In reaction to yesterday's cuts, the official administration announcement said, quote, it's clear that OPEC plus is aligning with Russia with today's announcement. Now for the administration, the stakes are quite clear. After intervening in oil markets throughout the year, U.S. gasoline prices fell for almost 100 days in a row from mid-June. During that time, the president's approval rating also increased, essentially moving inverse to gas prices at the pump. Now, with just a month left until what will likely be a close-run midterm elections, domestic gas prices have begun to creep up again over the last few weeks. policymakers everywhere reacted strongly. The White House statement said the president is disappointed

by the short-sighted decision by OPEC plus to cut production quotas while the global economy is dealing with the continued negative impact of Putin's invasion of Ukraine. At a time when maintaining a global supply of energy is of paramount importance, this decision will have the most negative impact on lower and middle-income countries that are already reeling from elevated energy prices. Bernie Sanders said OPEC's decision to cut back on production is a blatant attempt to increase gas prices at the pump that cannot stand. We must end OPEC's illegal price-fixing cartel, eliminate military assistance to Saudi Arabia, and move aggressively to renewable energy. Democrat Senator Chris Murphy from Connecticut called into question the efficacy of the current

alliance with OPEC. I thought the whole point of selling arms to the Gulf states, despite their human rights abuses, nonsensical Yemen war, working against U.S. interests in Libya, Sudan, etc. was that when an international crisis came, the Gulf could choose America over Russia and China. And indeed, there was lots of pointing to Russia here. Michael McFall, a professor of political science at Stanford and former U.S. ambassador to Russia, said, OPEC's decision today to cut oil supplies directly and immediately assists Putin's war effort. They were not compelled to do so. They chose to do so.

Don't ever forget it. Olivia Giuliana, the director of politics and government at Gen Z for Change, said OPEC and Russia's slashing oil and gas production is a targeted attack against democracy. This is being coordinated with the intention of painting democratic leadership in a negative light. They will let people across the globe suffer unlivable prices for political gain. Remember that. Javier Blas, the Energy and Commodities columnist at Bloomberg, said, by cutting oil output so much with Brent close to $100, OPEC plus is gambling with the global economy. It may just be pure business, an oil price that's good for Moscow also suits Riyadh, but it increasingly looks like politics too.

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Now, let's take a moment to step back and discuss the politics of this situation, and we're going to do so through Greg Carlston's thread. Carlston is the Middle East correspondent at the economist and writes, quick thread on oil, Biden, and Saudi, because there are a few distinct issues that get muddled in the conversation. Is the latest OPEC plus production cut meant as a snub to America? Is it perceived as one? And what does this all mean for the Saudi American relationship? First, is it meant as a snub. The oil market is a mess right now. OPEC has little spare capacity, many producers fail to meet their quotas, sanctions on Russia are bifurcating the market, all sorts of wildcards about demand, and so on. The Saudis have a rational interest

in keeping prices high. Trillion-dollar linear cities ain't going to pay for themselves. They and the rest of OPEC Plus also want prices to be stable, and they want the oil sector to lookrative enough that firms invest in building new capacity. All of this and more factors into decisions about how much oil to pump, which today are complicated decisions. It's a particularly American conceit to think that oil ministers decide what to do with a trillion-dollar industry dissuade the outcome of the Pennsylvania Senate race. Second, is this seen as a snub? Sure. Three months after Biden bent the knee in Jedda, OPEC plus delivers a big cut. But the White House helped create these optics, the timing of the visit and some private messaging, suggested Biden would secure quid pro quo on oil. People in Washington

got in their heads that a presidential visit would open a gusher of crude. That was never realistic as anyone in the Gulf would have told you before Biden arrived. If this seems like a snub, that's partly because of a misunderstanding. Last, what does this mean for the relationship? That's the hard question. You can understand some of the anger in Washington. The Saudi-American relationship is long been rooted in oil for security, and people feel like the Saudis aren't keeping up their end of the bargain.

Equally, though, the Saudis don't think America is fulfilling the security part. If the almost century-old foundation of this relationship is wobbly, then what is this relationship about? Unless someone comes up with an answer, it will continue to deteriorate. Now, Kristen Duwan, the senior resident scholar at Gulf States Institute, quote tweeted that thread and said, This is a good thread, but it ignores the geopolitical element of the OPEC plus effective Russian alliance. Taking this decision, in Europe, on the eve of what we all know will be a very difficult winter, is taking a political position, and it is not one Western partners would expect. Now, the American political dimension of this is a little outside the scope of the show, but two reflective takes that I think give you the bare bones.

Tommy Vitor, a former Obama staffer, said, MBS leading the charge to cut oil production a month from the midterms should be viewed as a deliberate political act. The Saudis want Trump to be president so they get total impunity for their human rights abuses, and staff like Kushner they can buy and sell. No more fist bumps. Alberto Fernandez, a retired U.S. diplomat, retweeted and said, The Saudis don't like the party of the leader who's promised to make them a pariah, wants to make their main export useless, and who seeks to deal with KSA's mortal enemy?

You don't say. Anyway, the most important question is what comes next. White House officials have reportedly asked the Energy Department to model the impact of a ban on exports of gasoline, diesel, and other refined petroleum products. This indicates that the controversial idea is gaining at least some traction within the administration. The U.S. had previously banned crude oil exports for four decades until that ban was lifted in 2015 during the Obama administration. On Tuesday, the largest oil industry trade groups wrote to the Biden administration that they have, quote, significant concerns about a potential export ban and urged policymakers to take the option off the table.

The U.S. has about 18 million barrels per day of refining capacity and exports around 3.5 million barrels a day of refined petroleum mostly to Latin American destinations. Republicans are not keen on this plan. Republican Representative Kathy McMorris Rogers of Washington said, I am warning this administration to not use this as an excuse to ban American exports or further their radical energy transition. Doubling down on failed policies will only further harm our energy sector and lead to more record high prices across our entire country. Another reaction to all of this was that lawmakers seized on the opportunity to revive a bill that has been proposed on an off for two decades.

It's dubbed the no-oil-producing and exporting cartels act or no-pec. The bill would allow the U.S. government to sue members of OPEC for manipulating the energy market. And while a lawsuit might be unlikely to come about due to sovereign immunity, the goal would be that the law would dissuade OPEC from acting brazenly. There's also discussions around the world of price caps. The EU is currently taking the next steps to apply a price cap to Russian oil. The Czech Republic, which serves as the current rotating president of the EU, said that the Economic Union had reached, quote, political agreement on the eighth sanctions package against Russia.

The package contains, quote, prohibition of maritime transport of Russian oil to third countries above the oil price cap and a ban on related services. The sanctions are in response to Russia's attempt to annex parts of eastern Ukraine under the pretense of a questionable referendum in late September. Russian deputy prime minister Alexander Novak has said that Russia may cut oil production to offset the effect of price caps, as well as refusing to supply countries that enforce the cap. Total Energy CEO Patrick Poyan said that price caps were a bad idea at the Energy Intelligence Forum in London, saying, quote, I think it's a bad idea because it's a way to give the leadership

back to Vladimir Putin. The market is already doing the work through large discounts. So whatever happens next, it's clear that this adds a new, complicating wrinkle in the U.S.'s fight against inflation and potentially eventually recession as well. Dan Pickering, the CIA at Pickering Energy Partners, wrote, food for thought, OPEC can cut more and longer than Biden administration can release from SPR. This OPEC meeting a wake-up call for U.S. politicians that energy inflation is going to be sticky. Clyde Russell, the Asia Commodities correspondent at Reuters, said, the decision by OPEC to cut its output quota by two million barrels per day raises both the risks of a sharper global economic downturn and the already high geopolitical temperature.

So that is the story with oil right now. There are economic dimensions, inflation dimensions, political dimensions, and the one common thread is that nothing is as simple as it might have seemed in the past. For now, I want to say thanks again to my sponsors, nexus.io, circle and FTX. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace. I want to tell you about CoinDesk's new event, the investing in digital

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