The Breakdown - What OPEC's Surprise Oil Production Cuts Have to Do With De-Dollarization

Episode Date: April 4, 2023

A reduction in oil output of 1.65 million barrels per day was announced by OPEC+ members on Sunday night. In the face of a global economic slowdown, analysts are debating whether the cartel is acting politically or merely anticipating softer demand.    Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   Join the discussion: https://discord.gg/VrKRrfKCz8   Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW   “The Breakdown” is written, produced and narrated by Nathaniel Whittemore aka NLW, with editing by Michele Musso and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. Music behind our sponsor today is “Foothill Blvd” by Sam Barsh. Image credit: by CoinDesk. 

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Big Picture Power Shifts remaking our world. The breakdown is produced and distributed by CoinDess. What's going on, guys? It is Monday, April 3rd, and today we are talking about OPEC surprise oil production cuts what they mean for not only oil markets but global geopolitics and how they are shaping the de-dollarization conversation. A quick note before we dive in, there are two ways to listen to The Breakdown. You can hear us on the Coin Desk Podcast Network feed, which comes out every afternoon and features other great Coin Desk shows. Or you can listen on the breakdown-only feed, which comes out a few hours later in the evening. Wherever you're listening, if you're enjoying the show, I would so appreciate it if you would take the time to leave a rating or review, it makes a huge

difference. All right, guys, welcome back to the breakdown. Recently when we've been talking about the macro, it's been pretty focused on monetary policy in the United States. However, there are forces out there that have a huge impact on the shape and texture of the global economy that have nothing to do really with Jerome Powell. And what's more, those forces aren't just about economic actions, but about political actions. I always say that the breakdown is about big picture power shifts and one of the major categories of power shifts are the global power realignments happening right now. That includes China emerging as a world's superpower and its various attempts to nudge the United States out of its leadership role, including trying to present an alternative to USDA.

Today's stories have elements of all of that, so let's dive in with a surprise oil cut that has the market's reeling. Member nations of OPEC announced surprise cuts to their oil production quotas last night on Sunday. The Saudi Arabia-led group of oil-producing nations announced cuts of 1.65 million barrels per day ahead of a scheduled meeting today. This caught traders off guard while markets were closed and has led to a pretty significant reaction. Both Saudi Arabia and Russia will reduce their production quota by half a million barrels per day, with the cuts going into effect from May through to the end of this year. Saudi Arabia's state media called the cuts, quote, a precautionary measure aimed at supporting the stability of the oil market. Russia's

reduction was announced two weeks ago and was likely more to do with bottlenecked capacity related to now implemented oil price caps rather than market considerations. Adding to October's cut of two million barrels per day, global oil supply has now contracted by around 3% over the last seven months. The White House commented that the cuts were ill-advised under current market conditions, stating that the administration will work with producers and consumers with a focus on ensuring that energy markets support economic growth and lower prices for American consumers. Now, as As recently as Friday, OPEC delegates had been indicating privately that there was no intention to cut production. Bloomberg's entire panel of 14 traders and analysts who were polled last week

had forecast no changes to quotas at this week's meeting. Last month, Saudi energy minister, Prince Abdulaziz bin Salman, said that the OPEC production targets set in October were, quote, here to stay for the rest of the year, period. Bin Salman has often delighted in catching speculators unprepared with unexpected supply changes. For example, following an intervention in September 2020, Bin Salman said, quote, we will never leave this market unattended. I want the guys in the trading floors to be as jumpy as possible. I'm going to make sure whoever gambles on this market will be outching like hell. Those caught on the short side of the trade were certainly outching like hell as the markets open this morning. The Monday session in Asia opened with more than a 6% gap

up, storing over $80 for barrel for the front month West Texas Intermediate or WTI contract. That's the U.S. benchmark crude oil futures contract. The WTI contract has been mostly since December, ranging between $75 and $80 per barrel. That said, during the week that Silicon Valley Bank collapsed, the oil price plunged below $67 amid concerns of a banking crisis-induced economic slowdown in the U.S. Contrast that with Bloomberg's lead headline this morning, which blared, what's next for oil after surprise OPEC plus cuts? Try $100 a barrel. So what is going into these cuts? What's the logic? Is it economic? Is it political? The most straightforward reason for the cuts is that global economic weakness is causing significant reductions in the demand for oil.

Last month's manufacturing data for both China and Germany came in soft, indicating broader-based weakness in the global economy. On top of that, hopes that China's reopening would spur demand appear to be faltering already. While no major region has entered a recession so far, concerns and signs of distress are mounting. Amrita Sen, director of research at Energy Aspect, said, quote, OPEC have made a preemptive cut to get ahead of any possible demand weakness from the banking crisis that has emerged. Indeed, a lot of the Twitter conversation was about why these cuts, while maybe short-term price bullish, actually suggests an assessment of medium and long-term global economic weakness. Citigroup analysts wrote, OPEC Plus's actions are clearly focused on

shoring up a market that was looking increasingly weaker. Given market positioning and short-covering, a spike now seems inevitable, but could be followed by realization that the market is a lot weaker than people think. Marco Papp's tweets, people shall be forgiven for approaching this topic over simplistically and suggesting a bullish outlook for oil. Saudi Arabia, cutting 500 barrels and the other market members reducing by 650 barrels per day is a sign of a weak underlying market and is unlikely to lead to rising prices. Russia has been successful in selling its oil since the war began, as evidenced by the rising fleet of tankers operating offside, which was underestimated by the market, and China's reopening has been far from

impressive so far. Unsurprisingly, since 1998, production cuts and increases led to price moves in the same direction. Mercatus writes, since April 1998, OPEC has announced 17 production cuts. About 40% of the time, the prices fell in the month that followed. Nearly half the time, prices were lower in both the third and six months following an announcement. Ted Talks macro writes, oil output cuts, bullish crude slash Brent in the short term, but longer term, this tells me that the Saudis and OPEC are worried about demand and disinflation. Andreas Dano Larson also points out the correlation between production cuts and price drops. He tweets, the oil price drops on average one, three, and six months after production cuts, typically a sign of weakness. Now, the relationship

that he's pointing out isn't causal, it's correlation. Production is going down because of an assessment of future weakness, that weakness shows up, and then prices go down. Still, this isn't the only explanation for what might be going on. Many are wondering if this is the latest move in a power struggle between Washington and Saudi Arabia. RBC's Halima Croft says, this move signals Saudi Arabia will seek to short circuit further macro selloffs and that Jay Powell is not the only central banker that matters. Washington and Riyadh simply have different price targets for their key policy initiatives. Commodity trader energy critic on Twitter writes, OPEC plus is in the driver's seat again. Welcome to the defining feature of the future of the oil market. While bullish oil, it's bearish

developed markets who are fighting inflation. One could suspect if you wanted to crush the West geopolitically, you'd keep the heat on inflation. Now, of course, throughout the last year, the Biden White House has been using the Strategic Petroleum Reserve to take the sting out of high gas prices. October's OPEC cuts were widely viewed as a pointed message to the administration just prior to the midterm elections, with rising gas prices a major issue at the polling booths. Last year saw the largest drawdown of the SPR in history. The sale of 180 million barrels took the reserve to its lowest point since 1983, with 371 million barrels remaining.

In October, the Department of Energy put forward a plan to replenish this stockpile by purchasing oil out of the open market. The intention it laid out was to purchase at prices between $67 and $72. While prices did touch that level, however, no purchases were made. In statements made 10 days ago, U.S. Energy Secretary Jennifer Granholm pushed back the timeline for these purchases into late 2023. Grandholm said, it will take a few years. It takes longer to refill than it does to extract. Alongside not refilling the SPR, the Department of Energy also recently signed contracts to sell an additional 26 million barrels, related to longer-term congressional mandates to use SPR sales as a mechanism to fund the government. The policy was set to run from 2024 to 2025, but a further 140 million

barrels in sales were cancelled in December to allow the Department of Energy more flexibility in using the SPR. Now, according to sources speaking with the Financial Times, Saudi Arabia has viewed this shift in policy as a slap in the face. The White House had urged the kingdom to assist with high inflation by pumping additional oil earlier last year as fuel prices began to spike, but no assistance was forthcoming. The pledge to refill the SPR was viewed by some analysts as an olive branch to Saudi Arabia, a soft indication that the White House would help put a floor under oil prices to allow more confident investment in bringing on additional supply. With the White House now non-committal on providing that price support, it's not exactly surprising that OPEC are taking precautions to control

supply with the risk of a nasty recession looming. Joe Wisenthal's piece for Bloomberg this morning effectively argued exactly this, that the SPR might have been a good tool of economic policy for the U.S., but not if they're not willing to fill it up, too. Joe writes, last year the White House introduced a potentially powerful new tool with its decision to sell down oil from the Strategic Petroleum Reserve, while simultaneously announcing its commitment to buy back that oil at lower prices in the future. The logic was simple and elegant. Spot oil prices were high, yet domestic producers were slow to ramp up production thanks to an uncertain demand future, by providing a purchase commitment, at least in theory, the White House was in a position to lower the price of oil in the short term,

while avoiding crushing domestic operators. Unfortunately, Joe writes, the White House's unwillingness to follow through on their commitments when oil prices did fall sharply suggests that they might have less credibility for this strategy going forward. The Strategic Petroleum Reserve has the potential, at least, to be a powerful counter-cyclical stabilizer that reduces the need for the Fed to do everything on the inflation front.

But this is a novel use, and for the SPR to work in this way, it has to have some credibility that its gears can turn in both directions. It needs to be able to boost the price of oil in a slump by being a buyer of last resort, and needs to be able to lower the price of oil in a boom by being a net seller. The U.S. is the world's largest producer of oil, but unlike the big OPEC players, there's no national oil company. We have no real policy tool for just announcing a cut or a hike in a domestic output. And now by failing to build out the SPR mechanisms, it looks like despite our size in this industry,

we're still outsourcing energy market stabilization to OPEC. Now, obviously, there would be a great debate to be had around whether the SPR should be used in this way, I just think it's interesting that Joe is pointing out that even if they wanted to, they might have blown an opportunity by not buying when they could have. Whatever the U.S. side of the equation, there is a lot of speculation around the shifting geopolitics of this. Halima Croft again, the head of commodity strategy at RBC Capital Markets, writes, it's a Saudi first policy. They're making new friends, as we saw with China. We see this closely held decision is just one more indication that the Saudi leadership is making its oil production decisions with a clear eye to their own economic self-interests.

Now, according to Politico, both the U.S. and Saudi Arabia deny any political motives in the dispute, however, careful observers are still noting the shifting sands. Last week, a Chinese state-owned energy firm made history by selling a liquid natural gas trade in yuan for the first time. The trade was conducted via the Shanghai Petroleum and National Gas Exchange on Tuesday between China National Offshore Oil Corporation and France's total energies. The deal involved around 65,000 tons of LNG exported from the United Arab Emirates. The trade is a milestone in the long history of China attempting to negotiate commodity settlements in yuan. Repeated negotiations have been held throughout the Middle East and North

Africa about conducting trade using the Chinese local currency. Last month, Iraq's central bank announced that it would settle trade in yuan, in part due to ongoing dollar shortage and restrictions from the Federal Reserve in an attempt to stop dollar flows into sanctioned Iran. In January, Saudi finance minister Mohamed al-Jadon told Bloomberg that the kingdom is open to trading in currencies other than the dollar in order to quote-unquote improve trade. This appeared to be a nod to comments made last year about considering pricing oil trades to China in Yuan. Egypt announced plans to issue yuan-denominated bonds in August of last year, while Israel added

yuan, along with Canadian and Australian dollars, to their foreign currency reserves last April. During a visit to Saudi Arabia in December, Chinese president Xi Jinping called on the Gulf states to make use of the Shanghai petroleum and natural gas exchange to conduct energy transactions in yuan, stating that China would, quote, make full use of the trading venue. Every time this theme of yuan-denominated trade pops up, commentators note that there is a massive difference in trades being priced in yuan and trades being settled in yuan. Individual trades are sometimes settled in foreign currency, with the most famous incident being a deal struck in 2000 for Iraq to settle oil trades in euros under the UN's Oil for Food Program. These individual

deals only impact the portion of global trades settled in non-dollar currencies. At present, the yuan is only used to settle less than 2.4% of global trade. Currently, all global benchmark commodities contracts are priced in dollars, and until that status quo is disrupted, for many, it's hard to see a pathway for the end of the dollar as the globally dominant trade currency. Now, that doesn't stop this from being one of the most fraught conversations on the internet. In short, you have a phenomenon that is important to watch, which is an attempt by an emergent superpower to muscle the USD out of its current role.

It also has marginal traction in some places, which is a notable and important thing to discuss and watch. But that gets blown to pieces because the debate people want to have is instead about the extreme possibilities of de-dollarization and the complete meltdown of the U.S. dollar system. Examples from just the last couple days. De Jolie writes, Saudi Arabia trades more with China than the U.S. and EU combined. And when Russia's partners switch to settlement in the national currency, the American House of Cards will collapse. Wall Street Silver writes there is a reason other countries are trying to do trade settlement in their local currencies. The U.S. is accelerating de-dollarization by issuing 10,000 unilateral sanctions on foreign entities over the last two decades. And under Biden, it is accelerating.

Now, it's not that the underlying phenomenon doesn't matter or aren't true, and I don't mean to call out these accounts specifically. It's a very common thing you see on Twitter. The problem is that racing all the way out to the furthest possible implications kind of undermines the value of the discussion in the moment we're actually living in. Now, to get a sense of what that conversation looks like, I turn perhaps not unexpectedly to Lynn Alden. On April 2nd, she wrote, the yuan flipped the euro to become Brazil's second biggest foreign exchange reserve currency. Dollar 80.42%, yuan, 5.37%, up from 0% prior to 2018, Euro 4.74%. Brazil also doubled their gold reserves in 2021. Matt O'Brien responded with a question, so is de-dollarization truly happening? Or is this a flash in the pan? Lin responded to that? Everything,

is on the margin. I think it's a great way of putting it. It doesn't have to be a major thing to seriously undermine roles of the dollar, including things like sanctions effectiveness. Still, for people who have been around for a while, this de-dollarization conversation is just a recurring theme. Brent Donnelly from Spectrum Markets writes, to anyone who is not trading in 2004 to 2006 or 2011 or 2000 and whatever, this de-dollarization BS shows up every now and then. Don't worry, it's pure engagement based, mostly from people who know better. And in case you think it's just anti-Bitkoiners with this perspective, Bitcoin's standard author, Safedina Moose, writes on March 30th,

there is no competition between the dollar and other fiat currencies, which are all just crappier, less liquid dollars with country risk and less open capital markets. Everybody wants to replace the dollar as the global reserve currency. Nobody wants to dump their treasuries and have less inflationary monetary policy and more open capital market than the U.S. So yes, it is notable, this LNG trade. But it does not mean that the dollar is going away anytime soon.

As to what the implications of these oil cuts are, although very much not an expert, my guess is that as much as they might be slightly politically charged, they probably are about getting out ahead of the widely held perception that the global economy is going into a slowdown period. If that's right, then they are a leading indicator of trouble ahead. Then again, for the stock market in the U.S., trouble ahead means in their minds a return to easy money, so who knows what will happen next in markets. Anyways, guys, that's it for today. appreciate you listening as always until tomorrow be safe and take care of each other peace