Unforeseen OPEC+ cuts prompt Asia to recalibrate buying strategy

The abrupt production cuts by OPEC and its allies may prompt Asia to recalibrate its buying strategy at a time when the region is witnessing demand recovery after years of pandemic-hit growth and spur increasing competition for crude from outside the supply bloc.

Although leading Asian buyers such as India and China may see a relatively smaller supply impact due to the relentless flows of Russian crude over the past year, what is more worrying for Asia overall is the anticipated surge in oil prices that could stoke inflation at a time the region is witnessing fragile economic recovery.

"The latest pledge to cut brings the total volume of cuts by OPEC+ to 3.66 million b/d, which would be a significant reduction for the oil market. And this will mean more competition for Asian refiners, especially as crude demand is expected to increase after the spring maintenance season," said Lim Jit Yang, adviser for Asia-Pacific oil markets at S&P Global Commodity Insights.

The unexpected production cuts announced by OPEC+ April 2 lifted crude oil futures more than 5% in early Asian crude April 3. At 10:30 am Singapore time (0230 GMT), the ICE June Brent futures contract was up $4.55/b (5.7%) from the previous close at $84.32/b, while the NYMEX May light sweet crude contract was $4.25/b (5.62%) higher at $79.92/b.

Inflation a bigger concern

OPEC and its allies said they plan to make more than 1.6 million b/d of voluntary production cuts, with the bulk of the reductions starting in May and lasting until the end of the year. Saudi Arabia and Russia will take the lead with reductions of 500,000 barrels each, followed by Iraq, the UAE and Kuwait.

"The surprise OPEC+ production quota cuts have propped up oil prices, which could stoke inflation as supply tightens further in the second half of this year. This could complicate decisions for central bankers, especially after the recent banking crisis," Lim said.

S&P Global forecasts global oil demand growing by 2.3 million b/d in 2023, driven by China, despite concerns over feared slowdowns in the US and Europe.

"The OPEC+ cut will further tighten supply in H2, when China is expected to see accelerated demand recovery. But in the short term, as China's maintenance season starts, crude demand in Q2 will fall from high levels seen in Q1, slightly offsetting the bullish factors," a Beijing-based source said.

In India, refiners were not unduly worried about the supply outlook, said Sumit Ritolia, refinery economics analyst for South Asia at S&P Global.

"Discounts on Russian-origin crude oil are providing a compelling refining margin on top of offsetting the high insurance and freight costs associated with purchasing and shipping crude oil," he said.

"With the Urals having assay qualities similar to Middle Eastern oil grades and advantageous lower sulfur content as compared to similar API Middle Eastern crudes, Indian refiners have swapped Middle Eastern crudes in favor of Urals for their refinery processing," he added.

South Korea is increasingly relying on Saudi crude oil, with the world's fourth biggest crude importer taking more than a third of its total refinery feedstock purchases from the OPEC kingpin.

Japan's reliance on Middle Eastern crude is at an all-time high, with imports from the region making up 98.1% of the country's imports in February, data from the Ministry of Economy, Trade and Industry data shows.

Market impact

"The volume of cuts is big and can fundamentally change the supply surface. If OPEC+ really cuts, then supplies will be short given the end of the turnaround season in Asia," a North Asian trader said.

Although Asian refiners do not expect their term Middle Eastern crude supplies to drop drastically, feedstock managers and middle distillate marketers said any uptick in outright benchmark oil prices and Middle Eastern crude spot premiums would once again hit Asian consumer confidence and fuel demand.

Some Asian refiners maintain they do not like seeing sharp declines in crude prices as it can mean they incur hefty inventory losses. They would also certainly wish to avoid having to sell their refined products at much lower prices than what they paid for their feedstock crude, according to trading and fuel marketing sources at PTT, SK Innovation and CPC Taiwan.

"OPEC+ is trying to get the market back to reviewing supply and demand fundamentals and they are adjusting when needed. If expectations don't change about the [US] Fed's next move, OPEC+ cuts will be supportive of the physical spot cargo market and the overhang of barrels will be cleared soon," a North Asian refiner said.

Analysts said the surprise cuts may not just alter trade flows but have also brought fragile diplomatic relations to the forefront.

"The announcement also crystalizes a further divergence between Washington and Riyadh, exacerbating fraught relations which had already deteriorated in recent weeks," Bernstein Research said in a note.