Last weekend, the OPEC+ alliance made a surprising announcement that sent ripples throughout the global oil marketsThe coalition, consisting of the Organization of the Petroleum Exporting Countries and allied producers, agreed to reduce output by nearly 1.7 million barrels per day, committing to this cut from next month until the end of the yearLeading the charge, Saudi Arabia pledged to curtail production by 500,000 barrels daily, with several Gulf nations following suitRussia, which had already declared a reduction of 500,000 barrels per day through June, decided to extend the cuts until the year's end.

This unexpected decision from OPEC+, while aligning with their known objective to maintain elevated oil prices, has shocked many observers

With the global market losing almost 1.7 million barrels of supply each day, it is foreseeable that oil prices will receive additional supportFollowing the OPEC meeting, West Texas Intermediate (WTI) crude prices surged, eclipsing the $81.80 mark before stabilizing above the $80 thresholdThe radical turn towards cuts hints at upward price momentum; unless there are unambiguous signs of weakening demand, projections suggest WTI could reach between $85 and $90.

WTI projected to rise to $85-$90

Weakening employment in the U.Sis unlikely to suppress oil prices

Regarding specific reductions, Saudi Arabia will cut 500,000 barrels per day, followed by Russia at 500,000, Iraq at 211,000, UAE at 144,000, Kuwait at 128,000, Kazakhstan at 77,000, Algeria at 48,000, and Oman at 40,000.

In the short term, supply anxiety will outweigh demand concerns, exerting more influence on oil prices

The significant cuts are raising speculation that oil prices may return to levels seen in 2022, posing potential new inflation challenges for the global economyInitially, these cuts might drive WTI from its current levels to at least $85-$90, though another plateau in the oil price may soon emerge.

Questions have arisen regarding whether weak employment data from the U.Scould have a profound impact on WTI pricesHowever, our assessment suggests a negligible effectIn periods of tighter household and business finances, elevated oil prices will undoubtedly impair demandYet in discussions around oil demand, the price has a limited impact; absent another significant event akin to COVID-19, don’t expect demand weakness to dramatically deflate oil pricesTravel and commuting behaviors are unlikely to change significantly due to high costs

Consequently, elevated oil prices could slightly impair demand but not eliminate it.

To put it another way, the backdrop of tepid U.Semployment numbers rekindles fears of an economic slowdown, yet they are unlikely to cause a downturn in oil pricesSpecifically, readings from the U.SISM and PMI employment components remain above the expansion threshold at 51.3, albeit down from last month’s 54.0. The ADP private employment change reported a mere 145,000 jobs added, compared to expectations of 210,000. Moreover, job vacancies plunged by 630,000 in FebruaryThese weakening employment metrics will heighten recession concerns, yet it is vital to note that the labor market remains resilient, as illustrated by the latest non-farm payrolls report.

Despite the steep drop in job vacancies, each unemployed American correlates with approximately 1.67 job openings

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In comparison, during the pandemic's height, each unemployed person linked to about 1.2 job openings within a formerly robust labor market.

Encouragingly, European data has also shown improvementFor instance, Germany's industrial orders rose by 4.8% in February, marking a significant rebound since recession fears ramped up in NovemberMoreover, Spain’s service and manufacturing sectors saw further enhancements in March, outperforming expectationsSpain's services PMI climbed to 59.4 in March, the highest since November 2021. These trends demonstrate greater resilience in the Eurozone economy, which may assuage near-term demand worries.

Uncertain long-term outlook for oil prices

Oil traders face a dilemma

Although the OPEC+ cuts are expected to tighten the oil market and potentially support prices in the short term, long-term prospects appear questionable

Sustaining high oil prices introduces the downside of inflation, implying that tighter monetary policies may endure longer than anticipatedEnormous drops in global oil demand may only occur under drastic economic downturns.

Thus, any future pressure on oil prices may primarily stem from supply-side factorsThis includes, for instance, a drastic increase from non-OPEC+ countriesWhile this scenario is plausible, these producers will require time to ramp up their outputA substantial increase could lead to OPEC+ losing market share, potentially igniting another supply battle with non-OPEC+ countries like the U.Sand Canada.

Following the united reductions by OPEC+ nations, the question of how much U.Scrude production can increase remains at the forefront of market interest

Back on January 25, the EIA predicted that U.Scrude output would reach record highs in 2023-2024, expecting an average of 12.4 million barrels per day in 2023, rising to 12.8 million barrels in 2024. However, practical scenarios indicate that U.Sproduction expansion capabilities are notably limited.

As for rig counts, the latest EIA data reveals a downward trend in the total number of rigs across the U.S.’s top seven production regionsAs of February 2023, the count stands at 708, tapering off by five since JanuaryWhether considering the overall rig count or shifts in per-rig production data, short-term U.Scrude production capabilities appear constrained.

In fact, U.Soil and gas companies have shifted focus in recent years

Rather than ramping capital expenditures and output when prices were high, firms have prioritized dividends or maintaining healthy cash flows, potentially due to America’s recent push toward clean energyGiven that U.Sproduction is highly tied to corporate capital expenditures, the potential for increased output remains limited in the near futureThus, even with the latest OPEC+ cuts, the American market share is unlikely to significantly encroach on their territoryMeanwhile, the U.Sgovernment continues tapping emergency reserves to exert downward pressure on prices, but this stockpile will eventually need replenishment.

In the short term, oil traders find themselves uncertain, torn between buying the dip or chasing after higher prices, all while fearing for missed opportunities for greater profits.

The colossal gap resulting from the unexpected cut declaration has largely remained unrefilled

Although gaps typically close after such jumps, this trend does not always hold trueWith the substantial foundational support following the announcement, oil prices may continue to rise past the initial gapTraders now seek stability around or slightly above the $80 mark to foster further price advances.

Conversely, if WTI prices retreat, filling most or all prior gaps, traders would hope to develop bullish signals before searching for new buying prospects.

Oil company stock prices are still dependent on economic trends

Caution necessary regarding high oil stock retracements in 2023

In 2022, the energy sector was the sole winner among the eleven sector indices of the S&P 500, skyrocketing by 58%. Unsurprisingly, the surge in energy prices driven by conflicts stood as the primary factor.

In the backdrop of an energy crisis, traditional fossil fuels are back in favor

Last year, coal prices soared by 140%, while although crude oil and natural gas significantly dropped in the latter half, they still maintained over 10% annual increases.

In the capital markets, Warren Buffett's ongoing acquisitions of Western oil firms have spotlighted their sound balance sheets and profitability outlooksTake ExxonMobil (XOM), for instance; its net profits for the past three quarters reached $5.48 billion, $17.85 billion, and $19.66 billion (almost rivalling Apple’s $20.7 billion in net profit for the same quarter), with stock prices peaking in November before currently outpacing Tesla in market capitalization.

Such staggering profitability is buoyed by demand from the European marketFollowing the severing of stable and inexpensive energy supplies from Russia, Europe unabashedly imported liquefied natural gas and other energy products from the U.S., filling the market void left by Russia and emerging as one of the principal beneficiaries of the energy crisis