Global recession fears as oil shock leaves Russia smiling and the West seething

Saudi Arabia’s decision to align itself with Russia and supersize OPEC Plus’ oil production cuts will have significant geopolitical and economic consequences.

The announcement of the two million barrels a day reduction in OPEC+ output infuriated the White House, delighted the Russians and raised fears that a new surge in oil prices could lead to higher-for-longer interest rate rises and an increased risk of global recession.

Russian President Vladimir Putin and Saudi Arabia’s King Salman in 2019.Credit: AP

The White House had lobbied the Saudis and other Middle Eastern producers hard in recent months – including via a visit by Joe Biden to Saudi Arabia in July – urging them to increase production. Having had its efforts so conclusively and embarrassingly rebuffed, it is now warning that it will consult Congress on mechanisms “to reduce OPEC’s control over energy prices.”

That’s an implicit threat to enact a piece of legislation – the “No Oil Producing and Exporting Cartels Act,” or “NOPEC” bill – that has been debated in Congress more than a dozen times over two decades but never enacted. It would remove an anti-trust exemption for the OPEC cartel, allowing the US Department of Justice to deploy America’s intimidating anti-trust laws against OPEC’s members and their oil companies.

OPEC, led by the Saudis, presented the decision to cut output by two million barrels a day, or about two per cent of global supply, as necessary to stabilise a recent fall in oil prices and incentivise investment even though prices have been relatively high by historical standards.

The oil price rose $US1.57 to $US93.37 on the announcement of the cut, which was much larger than the 500,000 to one million barrels a day mooted ahead of the meeting of the OPEC+ alliance in Vienna.

Russia’s deputy prime minister, Alexander Novak, attended the meeting which was held even as the European Union was agreeing to a new package of sanctions on Russia, including a price cap on sales of Russia oil.

The cap, an EU embargo on purchases of Russian oil and a sanctions-backed denial of insurance and finance to anyone transporting Russian oil sold at prices above the cap will come into effect on December 5.

Russia’s oil sales volumes have already fallen about a million barrels a day from their levels before the invasion of Ukraine and would be expected to fall again after the EU and US sanctions are in place in December.

The effect of the OPEC+ production cuts should be to increase oil prices and help offset the volumes losses with the price gains, even if Russia is forced to continue to discount its oil significantly to attract buyers.

With the midterm elections looming next month, the last thing the Biden administration wants is to see the recent decline in petrol prices and in their prominence in US political discussion reversed.Credit: AP

It will also give Russia a lot more leverage over the oil market.

It has threatened to cut its own production by as much as three million barrels a day in response to the EU and US plans. In a tight market – most OPEC members have been struggling to meet their current production targets and oil inventories are well below historical averages – the combination of OPEC and Russian cuts could have a dramatic impact on the oil price.

OPEC’s core, particularly the Saudis, had a choice to make at the Vienna meeting. They either sided with Russia, the “plus” in OPEC+ since it became associate member of the cartel about six years ago, or with the Saudi’s long-time ally, the US. They chose Russia, the world’s third-largest oil producer behind the US and the Saudis.

That may have been because they saw the sanctions on Russian oil as a threat to their own position and power over the oil market.

In effect the US and EU have created a structure that looks very much a buyers’ cartel. Wider deployment of that structure and the dominance the EU, UK and US have over the insuring and financing of oil shipments, could threaten the influence OPEC has had over the market since its cartel was formed more than 60 years ago.

That, and the perceived need to keep Russia onside and within the cartel, has proven more powerful influences than the Saudis’ long-standing relationship with the US and the prospect that the relationship might be poisoned by the choice the Saudis have made.

The US was infuriated, not only because the OPEC+ decision will help Russia fund its war in Ukraine, but because petrol prices have both domestic political and global economic implications.

With the midterm elections looming next month, the last thing the Biden administration wants is to see the recent decline in petrol prices and in their prominence in US political discussion reversed.

In the longer term the choices the OPEC core made could be self-harming. They will force oil-consuming economies to try to reduce their consumption and accelerate their existing shifts towards alternate forms of energy.

More broadly, should oil prices rise significantly as a result of the production cuts they will feed into higher inflation rates around the world than would otherwise be the case and force central banks to keep raising interest rates and holding them at higher levels than they would otherwise have done.

The prospect of a global recession has been increased by OPEC+’s decision. While the EU and UK would be most at risk, given that they are already experiencing energy crises and are on the brink of recessions, the rest of the world is also exposed to a sustained period of high oil prices.

How much impact the cuts will have on oil prices isn’t clear.

The talk of a 500,000 to one million barrels a day cut in the lead up to the cartel’s meeting had only modest impacts on oil prices because many OPEC members are already producing well below their targets.

Joe Biden with Saudi Crown Prince Mohammed bin Salman in July during his visit to try and push for increased oil production.Credit: AP

Oil industry analysts are saying that the two million barrels a day cut to output will, for that reason, be more like a one million barrels a day reduction with the Saudis (who have been producing at or above their own target levels) contributing more than half that amount.

That’s still material and will become even more so if Russia follows through on its threat to throttle its output and/or China, whose demand for oil has been soft because its economic growth has been so severely impacted by its zero-COVID policies, were to relax those policies and lift its growth rate and oil consumption.

In the longer term the choices the OPEC core made could be self-harming. They will force oil-consuming economies to try to reduce their consumption and accelerate their existing shifts towards alternate forms of energy.

In the long term, that could be very positive for the efforts to reduce global carbon emissions. In the near term it could be painful.

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