JJE - OPEC Cuts Nearly 1.2 Million Barrels Per Day WTI Oil Surges Higher: Winners And Losers

2023-04-02 19:32:10 ET

Summary

• OPEC+ shocked markets by announcing a surprise cut of nearly 1.2 million barrels per day.
• The motive? Profit. While paying lip service to recession risk, the move is designed to restrict the supply of oil before the busy summer travel season.
• This comes amidst an ongoing chess match between the Biden administration and the Kingdom of Saudi Arabia.
• A Financial Times report suggests that the Biden administration angered Saudi Arabia by declining to refill the Strategic Petroleum Reserve when crude oil prices were low, so the Saudis decided to get some payback.
• Oil prices are up 7% in the Asian session as of my writing this. We break down the winners and losers from the surprise move.

Over the weekend, OPEC+ roiled markets with production cuts of over 1 million barrels per day. Led by Saudi Arabia, the move is designed to take roughly 1% of global oil production offline before the busy summer travel season. This follows a Goldman Sachs report last month that oil could top $107 per barrel by year-end. After the failure of Silicon Valley Bank, oil markets had plunged on widespread recession fears. But after a week of no new bad news in banking, the move sends a message to traders that if the US somehow escapes recession, a new inflation surge could be on the horizon with the Saudis signaling an attempt at cornering a large part of the oil market. WTI Crude oil is up about 7% to $81 as of my writing this on Sunday night.

Winner: Warren Buffett

Warren Buffett made headlines for a series of purchases in shares of Occidental Petroleum ( OXY ) during the March panic. These now look extraordinarily well timed. Bloomberg reported that Buffett bought over $800 million in OXY shares during the March panic. With oil prices set to rocket higher again, Buffett is now looking at a paper profit in the nine-figure range. Not bad work if you can get it! Other big oil companies like Exxon Mobil ( XOM ), Chevron ( CVX ), ConocoPhillips ( COP ), and EOG Resources ( EOG ) are likely to rally off the news.

Winner: Saudi Arabia

The surprise move to cut production comes after OPEC+ delegates this week signaled that they weren't likely to cut production. Of course, they then followed this up with big cuts to production less than 72 hours later. Financial Times reported that the Biden administration had previously promised the Saudis that they would refill the US Strategic Petroleum Reserve if prices fell into the 60s, but reneged on the promise. This apparently ticked the Saudis off quite a bit.

From a purely game theory perspective, the Biden admin's gambit might have worked if the Saudis were unable to rally OPEC+ members to cut production in a short period of time. However, everyone on their end seems aligned and they were able to jam through the production cuts they wanted.

This comes after a series of diplomatic incidents between the United States and the Kingdom of Saudi Arabia. For better or worse, gas prices serve as a report card on whoever is in office in the US for millions of voters. High gas prices stoke discontent, while low gas prices tend to favor the status quo. Historically, Saudi Arabia has shown a strong tendency to exploit voter tendencies in the US by raising and lowering production. That's why there's a long history of apparent deals to raise or lower oil prices before US elections. Politics led to the OPEC oil embargos in the 1970s that caused gas shortages in the US. This time around, an NYT report stated that the Saudis reportedly duped the Biden admin, cutting production right before the 2022 midterms after supposedly promising not to in a July 2022 presidential visit to Saudi Arabia.

In contrast to most of continental Europe, Japan, and a few other first-world countries that lack oil significant resources of their own, the US economy at large is more or less neutral on oil. Higher oil prices mean more profits for producers but less money in consumers' pockets. But for the Biden admin's perception among voters, higher gas prices are an unmitigated negative. The US economy could still come out OK with this if domestic production increases and takes market share from OPEC. But then there's always the threat that the Saudis turn around and flood the market with oil later , as they have repeatedly done in the past. The US called the most recent move by the Saudis and OPEC " inadvisable ." Messy stuff.

Saudi Arabia looks like the winner here, and implicitly, for them to win means the Biden admin loses.

Winner: EV Manufacturers

If gas prices face a continued spike, Tesla ( TSLA ) and other manufacturers are likely to see increased consumer interest in their products. In contrast, manufacturers that sell a lot of luxury SUVs and pickups are likely to see softer sales, especially in the face of a double whammy of higher rates and higher gas prices. Legacy manufacturers that produce both EV cars and ICE cars are likely to see fewer effects.

The EV stock picture is more complicated because so many EV stocks carry absurd valuations– i.e. Tesla going up nearly 100% this year against declining earnings estimates. For their underlying businesses, however, high oil prices will be good.

Loser: Airlines

Higher oil prices are toxic to airlines, which are counting on a big summer travel season to recoup losses from the pandemic and re-establish their financial position. The exact impact will depend on how long oil prices stay high, and whether the airline in question is partially or fully hedged for fuel. Airlines disclose fuel hedges in their public 10-Q filings, so that's the place to look for updated news. Recent headlines have shown that at least a few airlines have pared back hedging fuel in hopes that prices would fall further. It's worth monitoring trading American Airlines ( AAL ), JetBlue ( JBLU ), and Southwest Airlines ( LUV ) early this week to gauge the market reaction.

Loser: Soft Landing Hopes

With heightened uncertainty over both growth and inflation, higher oil prices are the last thing the US and global economy need now. In the US, the most severe economic weakness so far is being seen in California, as evidenced by bank failures, rapidly falling property prices, and population outflows. Californians have long commutes , typically face the second-highest gas prices in the country behind Hawaii, and are seeing more pressure due to rising interest rates than less indebted peers. Higher gas prices are going to put a lot of pressure on the middle class there, and on the West Coast more broadly.

The US is a bit of an outlier globally in terms of sensitivity to gas prices. Salaries are generally high, while fuel is cheap. Emerging markets are the worst in terms of sensitivity to higher energy prices, while Europe also is likely to be sharply affected due to the supply issues they were already having with energy due to the war. In general, higher oil prices are bad for hopes of lower inflation and higher growth.

Bottom Line

While I get that bulls are excited stocks have rallied sharply, there's a lack of breadth in the market, with obnoxious speculative stocks up 50% to 100% this year, while the average stock is flat to down. The surprise cuts from OPEC+ are a reminder that inflation is far from conquered, while growth issues remain. The market likely will not be able to have it both ways. While we could see inflation fall sharply in a recession, the OPEC+ cuts virtually guarantee that if we don't get a recession in the near future, inflation is going to continue to be a significant problem.

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