Last weekend,the OPEC+ alliance made a surprising announcement that sent ripples throughout the global oil markets.The 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 year.Leading the charge,Saudi Arabia pledged to curtail production by 500,000 barrels daily,with several Gulf nations following suit.Russia,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 support.Following the OPEC meeting,West Texas Intermediate (WTI) crude prices surged,eclipsing the $81.80 mark before stabilizing above the $80 threshold.The 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.S.is 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 economy.Initially,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.S.could have a profound impact on WTI prices.However,our assessment suggests a negligible effect.In periods of tighter household and business finances,elevated oil prices will undoubtedly impair demand.Yet 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 prices.Travel 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.S.employment numbers rekindles fears of an economic slowdown,yet they are unlikely to cause a downturn in oil prices.Specifically,readings from the U.S.ISM 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 February.These 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.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 improvement.For instance,Germany's industrial orders rose by 4.8% in February,marking a significant rebound since recession fears ramped up in November.Moreover,Spain’s service and manufacturing sectors saw further enhancements in March,outperforming expectations.Spain'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 anticipated.Enormous 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 factors.This includes,for instance,a drastic increase from non-OPEC+ countries.While this scenario is plausible,these producers will require time to ramp up their output.A substantial increase could lead to OPEC+ losing market share,potentially igniting another supply battle with non-OPEC+ countries like the U.S.and Canada.

Following the united reductions by OPEC+ nations,the question of how much U.S.crude production can increase remains at the forefront of market interest.Back on January 25,the EIA predicted that U.S.crude 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.S.production 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 regions.As of February 2023,the count stands at 708,tapering off by five since January.Whether considering the overall rig count or shifts in per-rig production data,short-term U.S.crude production capabilities appear constrained.

In fact,U.S.oil 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 energy.Given that U.S.production is highly tied to corporate capital expenditures,the potential for increased output remains limited in the near future.Thus,even with the latest OPEC+ cuts,the American market share is unlikely to significantly encroach on their territory.Meanwhile,the U.S.government 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 true.With the substantial foundational support following the announcement,oil prices may continue to rise past the initial gap.Traders 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 outlooks.Take 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 market.Following 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.Even amid recessionary cycles characterized by weak demand,U.S.energy giants—boasting low production costs,ample reserves,diversified operations,and a potentially vast market—are well-equipped to withstand this "harsh winter" (ExxonMobil's breakeven price is estimated to hover around $41 per barrel).Moreover,generous dividends and stock buyback programs stand as vital elements in preventing drastic stock downturns.

However,fund flows this year may divert toward government bonds,gold,consumer staples,and utility sectors,alongside certain oversold growth stocks,making it a challenging year for the energy sector (XLE) to replicate the triumphs of 2022,thus necessitating awareness of possible high retracement risks.