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How China And The U.S. Were Both Key To OPEC+’s Bearish Oil Supply Cuts

After long delays, last week saw OPEC+ announce oil production cuts way below what many oil traders had been expecting, causing the benchmark Brent oil price to drop over 2 percent immediately on the news, to just over US$80 per barrel (pb). Saudi Arabia announced merely a rollover of its previous voluntary 1 million barrels per day (bpd) cut, and Russia did the same for its 500,000 bpd cut (although only 300,000 bpd of this is crude oil, with the remainder being refined products). Both these rollovers will run from 1 January until 31 March, whereupon they will be reviewed again. Consequently, the only price-swing element in the OPEC+ oil supply cuts was a collective reduction of 696,000 bpd of crude oil from other members. Given the previously cavalier leadership of the OPEC members of the broader OPEC+ group by Saudi Arabia - characterised by the desire to raise oil prices significantly for sustained periods - the question for oil traders is what does the latest muted action mean for prices going forward?

The key to this is to determine what the key factors were behind this damp squib of a decision, and one of the two principle reasons was China. Since the mid-1990s, Beijing had been banking on extremely strong economic growth to enable it to equal and then surpass the U.S. as the top economic and military superpower on the planet. For many years, the plan seemed to be on track, with the economy growing at a double-digit rate, which in turn fuelled China's appetite for the energy to drive this growth, which in turn made it the catalyst for the commodities supercycle seen during those years. As late as 2017, its high rate of economic growth allowed it to overtake the U.S. as the largest annual gross crude oil importer in the world, having become the world's largest net importer of total petroleum and other liquid fuels in 2013. This pivotal role in the global oil and gas sector provided China with the ideal lever for it to advance its broader economic and political objectives into the key providers of these energy sources across the Middle East, under the cover of its 'Belt and Road Initiative' (BRI). These BRI programmes have been characterised by massive loans extended by China to around 150 countries, with little hope of some of them ever being able to repay what is owed. An inability to do so contractually allows China to exercise various Draconian penalties, including the seizure of key assets in these indebted countries, as analysed in depth in my new book on the new global oil market order. In short, these 'Hotel California-style' BRI deals ("You can check out any time you like, but you can never leave") - and its oil and gas buying power - have given China a vice-like grip over several of the Middle East's top energy producers.

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When Beijing's plan was still going strong, it was happy enough to allow OPEC+ to do largely as it wished in the matter of attempting to increase oil prices by a lot for as long as it wanted. That period coincided with a time when China wanted to see the rift between the Middle East and its former previous top superpower sponsor - the U.S. - grow as much as possible. The Trade War between Beijing and Washington was at its height, and the U.S. had never been so vulnerable in the Middle East as it was then. From 2014-2016, Saudi Arabia and its OPEC brothers had launched, fought, and lost the Second Oil Price War with the U.S., leaving the Middle Eastern economies in ruins and anti-U.S. feeling running high, as also analysed in depth in my new book on the new global oil market order. Shortly afterwards, in May 2018, the U.S. had unliterally withdrawn from the 'nuclear deal' with Iran, leaving Saudi Arabia and several of its OPEC brothers more exposed than ever to their long-term nemesis. And shortly after that, the U.S. began a wholesale drawdown of its on-the-ground presence in the Middle East, including from Syria in 2019, Afghanistan in 2021, and from Iraq in December 2021. China gleefully stepped into the power vacuum created by the U.S. through its BRI projects and by leveraging the influence that Russia had built up in the region over decades, especially across the Shia Crescent of Power, centred on Iran and Syria.

Things are different now in China and have been so since its disastrous handling of Covid when it emerged there at the end of 2019. With its 'zero-Covid' policy involving repeated instant shutdowns of major cities, the economy plummeted, and growth has remained difficult to come by since the country officially reopened from Covid at the end of 2022. It is likely to achieve its economic growth target this year of "around 5 percent", but the going has been extremely difficult, and has involved some uncharacteristic recent financial maneuverings out of Beijing. In addition, the spectre of a hugely indebted property sector - which comprises at least 30 percent of China's entire economy - hangs over the country, looking ready to implode at any moment. By contrast, the U.S.'s economic recovery from the Covid years has been strong, and it may well be that China's moment to overtake it as the world's top superpower, either economically or militarily, has now been paused, perhaps lost entirely.

China's delicate economic position, then, means that it cannot afford any further shocks, and this includes a dramatic reduction in demand from the West for its exports. Of course, China can buy oil and gas at 30 percent or more discounts from its key suppliers by dint of various agreements made by it since the U.S. withdrew from the 'nuclear deal' with Iran in May 2018. In this sense, then, rising energy prices would have little direct effect on it, and its long-term contracts with Middle Eastern suppliers guarantee no supply disruptions as well. Crucially though in China's calculations is the fact that the economies of the West remain its key export bloc. The U.S. still accounts for over 16 percent of China's export revenues on its own. According to a senior source in the European Union's (E.U.) energy security complex, and another source in a similar role in the U.S., both spoken to exclusively by OilPrice.com recently, the economic damage to China - directly through its own energy imports and indirectly through damage to the economies of its key export markets in the West - would dangerously increase if the Brent oil price remained over US$90-95 pb for more than one quarter of a year.

China's fragile economic position also means that it has once again needed to be more cognisant of U.S. concerns, especially when one of its key geopolitical allies - Russia - continues its war against Ukraine, threatening the Washington-led NATO security alliance's eastern flank. China's more diplomatic stance in recent months - as its economic recovery has struggled to assert itself - has been seen in its assistance to the U.S. in preventing the Israel-Hamas War from widening out, using the very same levers that it had established to aid its own advance across the Middle East over the past five years in particular.

For the U.S., as also analysed in detail in my new book on the new global oil market order, Washington has long targeted a ceiling Brent oil price of US$75-80 pb, and a floor of US$40-45 pb. During the presidency of Donald Trump, this US$75-80 pb ceiling was seen as the price after which economic threat becomes apparent to the U.S. and its allies, and a political threat looms for sitting U.S. presidents. The US$40-45 pb floor was regarded as the price at which U.S. shale oil producers can survive and make decent profits. When Saudi Arabia (with the help of Russia) was pushing oil prices up over the US$80 pb of Brent level in the second half of 2018, Trump in a speech before the United Nations General Assembly said: "OPEC and OPEC nations are, as usual, ripping off the rest of the world, and I don't like it. […] We defend many of these nations for nothing, and then they take advantage of us by giving us high oil prices. Not good. We want them to stop raising prices. We want them to start lowering prices and they must contribute substantially to military protection from now on." In short, during Trump's entire presidency, the US$80 pb oil price ceiling was breached only once for a period of around three weeks from the end of September 2018 to the middle of October 2018. Trump may well be back as President at the end of 2024, but even if the Democrats win again, they have shown the same desire to keep oil prices within that range.

By Simon Watkins for Oilprice.com

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Simon Watkins

Simon Watkins is a former senior FX trader and salesman, financial journalist, and best-selling author. He was Head of Forex Institutional Sales and Trading for… More