Saudi Arabia deepens oil output cuts into summer season

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Brent crude oil prices rose on Monday after Saudi Arabia on Sunday announced a surprise 1 million barrels per day (mbpd) production cut from July, its biggest one-off reduction in years. The voluntary cut came alongside an OPEC+ deal to extend group curbs for another year to end-2024, as producers seek to put a floor under crude prices.

This marks the second such OPEC+ cut announced this year. The prior example in April had only a brief impact on prices, with markets quickly refocusing on growth risks and the rate outlook. While the action may renew investor concerns over softening oil demand fundamentals, we see several reasons crude prices are likely to climb from here:

Saudi Arabia’s steep cuts add credibility to the strength and longevity of OPEC+ curbs. Saudi stands out among its peers for its track record of delivering on pledged output cuts, and we would expect the 1mbpd in promised cuts for July could be extended if market conditions support it. Saudi’s unilateral action stands out, in part reflecting its storage capacities and scale. But we also note that nine oil producers in total extended their voluntary cuts to end-2024, suggesting unity among producers on bringing up prices.

Market balances for crude oil are likely to tighten meaningfully. With this latest round of Saudi-led OPEC+ cuts, we expect oil production to fall back toward 100mbpd in 2Q23, against nearly 101mbpd in the first quarter this year. At the same time, demand is likely to approach 102mbpd in June, fueled by the driving season in the US and more oil being used to generate power to cool down buildings in the Middle East.

The International Energy Agency's latest monthly report also forecasts tighter market conditions in the second half of the year, with demand projected to outpace supply by almost 2mbpd even without the latest Saudi cuts. With demand outpacing supply, we expect data to point to declining inventories in the coming months.

So, despite the modest market reaction to the Saudi-led cut, we take this as a bullish outcome that should further support prices into the second half. We keep oil as most preferred and forecast Brent crude at USD 95 a barrel by end-2023, up from USD 77.90/bbl at present. We like longer-dated oil contracts and recommend selling volatility in Brent crude oil.

This constructive view on oil factors into our most preferred stance on broad commodities, with an anticipated 20% total return forecast by June 2024. Investors may also consider other “real” assets, such as infrastructure investments that can help stabilize long-term income generation in a multi-asset class portfolio.