Oil prices have surged by 15% following the announcement of a production cut by oil-producing countries Saudi Arabia and Russia. This move aims to counter weak global demand for oil, but concerns remain regarding whether the price increases will remain stable. On Sunday, the oil cartel OPEC announced a substantial production cut of 1.6 million barrels per day, nearly 2% of global production, which was unexpected as it took place outside of their regular consultations.
However, the situation seems to be repeating itself as in the previous OPEC intervention last October, prices spiked following a hefty production cut of 2 million barrels per day, only to fall again in the following months. The cut was not as tough as it seemed on paper since many OPEC countries were not meeting their production targets due to overdue investments and poor maintenance. This time, it appears to be no different as the measure is voluntary, and OPEC members do not have to participate.
For the time being, seven of the 13 members are participating, and it remains to be seen what Russia will do. Russia has officially joined, saying it will push through a previously introduced production cut of 500,000 barrels per day until the end of this year instead of the end of June. However, it hardly seemed to take that restriction seriously until now. Furthermore, Iran and Venezuela are not participating, which could undermine the impact of the production cut.
In addition to these uncertainties, oil-producing countries face pressure from public opinion and policymakers in the West to shift towards greener energy supplies, which will reduce the long-term demand for oil. For example, the European Union aims to be climate neutral by 2050, and there are plans to ban the sale of new gasoline and diesel cars in Europe by 2035.
Despite these challenges, short-term prospects for the oil industry may improve if China, the world’s second-largest economy, returns to strong growth in the coming months. China’s energy demand will rise sharply, and so may oil prices. Based on this possibility, business bank Goldman Sachs raised its forecast for oil prices later this year by five dollars, from $90 to $95.
However, the paradox is that new, high energy prices could drive inflation again, which would force central banks to raise interest rates further. This kind of move would depress economic growth, with all its consequences for oil demand.
Moreover, the production cut also carries risks for oil-producing countries, including the potential for friction with former ally, the United States. The US, the world’s largest oil producer, wants oil production to be increased to keep fuel prices low. Additionally, production cuts may cause new disruptions in the West, as high energy prices caused extreme inflation last year.
While the production cut may provide a temporary solution, it is clear that the long-term solution lies in diversifying economies and embracing alternative energy sources. Saudi Arabia, in particular, needs higher oil prices to reform its economy and transition away from dependence on oil. The country’s ambitious Vision 2030 plan aims to reduce the country’s reliance on oil by increasing investment in non-oil industries and developing a more diverse economy.
Similarly, Russia is waging a money-making war on Ukraine, and the country needs to look at diversifying its economy and reducing its dependence on oil exports. The production cut could provide Russia with short-term financial relief, but it is not a sustainable solution to the country’s economic problems.
The production cut announcement has highlighted the structural problems facing the oil industry, and it is clear that change is needed. The push towards greener energy sources is gaining momentum and countries that fail to adapt risk being left behind. Oil-producing countries will have to embrace the changing landscape of the energy industry and invest in alternative energy sources and other industries.
