Saudi Arabia Shocks Markets With Oil Supply Cut: What This Means For Elevated American Inflation

Saudi Arabia Shocks Markets With Oil Supply Cut: What This Means For Elevated American Inflation

oil supply cut

Saudi Arabia Crown Prince Mohammed bin Salman talks with Russian President Vladimir Putin at the G-20 summit in Osaka, Japan, June 28, 2019. (AP/Susan Walsh)

Oil prices rose on Monday after some of the world’s biggest oil-producing countries led by Saudi Arabia agreed to reduce production by more 1 million barrels a day, raising concerns of continuing inflation in the U.S. economy.

The move is a significant reduction and represents the abandonment of earlier OPEC assurances that it would keep supply steady, posing a new risk for the global economy, Bloomberg reported.

Markets had been betting that a slowdown in the inflation rate might cause the U.S. Federal Reserve to slow the pace of interest rate hikes, but the surprise production cuts present a new inflation headache, The Street reported.

After Saudi Arabia promised to cut its supply by 500,000 barrels a day, Kuwait, the United Arab Emirates and Algeria followed. Russia said its production cut would continue until the end of 2023. 

“OPEC+ clearly want a higher price,” said Gary Ross, a veteran oil consultant-turned hedge fund manager at Black Gold Investors LLC.

U.S. gas prices, which dropped Sunday to a national median of $3.99 per gallon, could rise 15 cents per gallon in the next few days due to higher oil prices, according to Patrick de Haan of the consumer advocacy group Gasbuddy.

“This looks like a pre-emptive move from the (OPEC) cartel ahead of a likely economic slowdown – and possible recession in the US – later this year,” Larry Elliott wrote for The Guardian. “OPEC+ said its decision was aimed at ensuring stability in the oil market, by which it means putting a floor under oil prices of about $80 a barrel … It is a sign of the cooling of relations between Washington and Riyadh that the Saudis went ahead with their voluntary production cut despite strong opposition from Joe Biden’s administration.”

The surprise oil supply cut by OPEC came at a bad time for the U.S. as it battles to slow the rising cost of living. Higher oil prices mean higher transportation costs and less money for consumers to spend on food and housing. Russia’s invasion of Ukraine triggered higher energy costs in 2022. Central banks have been expecting inflation to fall in 2023 but the OPEC move threatens to make inflation longer and more drawn-out, The Guardian reported.

Oil price increases will disrupt supply chains and lead to higher inflation expectations, said Nigel Green, CEO of London-based financial advisory deVere Group.

“There’s real concern that the surprise decision announced by Saudi Arabia for OPEC+ will prompt central banks to maintain interest rates higher for longer, due to the inflationary impact, which will hinder economic growth,” he added.

A potential inflationary bump from the oil supply cut and higher crude prices has already impacted Fed rate forecasts, The Street reported. CME Group’s FedWatch now indicates a 62 percent chance of another 25 basis point rate hike in May and a 59.2 percent chance that Federal Reserve Chairman Jerome Powell will hold that rate in place through June.