The right kind of volatility returned on Monday as the S&P 500 jumped 2.6% to start the fourth quarter.[i] But stocks aren’t the only thing that has risen. Crude oil prices also jumped, largely on rumors that OPEC and its partners plan to cut their production target by one million barrels per day (bpd) at this week’s meeting. Cue fears of a sharp cut fueling (sorry) another spike in oil prices, exacerbating this year’s inflation and deepening existing economic headwinds. This is understandable from a sentiment perspective and in line with the fears driving this year’s bear market. Yet we also believe it is quite out of sync with oil supply and demand, not to mention the way oil prices have behaved since the spike caused by the invasion of Ukraine by Vladimir Poutine.

Table 1 shows world oil prices since the beginning of the year. As you’ll see, crude rose on the eve of the invasion and spiked right after, hitting its highest year-to-date on March 8. It was, you may recall, the day the UK announced its decision to ban Russian oil. imports, heightening fears of a sudden supply crisis. But since the summer, oil has fallen steadily as it became clear that Russian oil was finding buyers and global supply was resilient. Oil prices are now just around pre-war levels in Ukraine.

Exhibit 1: Brent crude oil in 2022

Source: FactSet, as of 03/10/2022. Brent crude oil spot price, 31/12/2021 – 30/09/2022.

Based on our sentiment reading, oil’s decline is not widely appreciated. We suspect this is because past high oil prices continue to fuel consumer price inflation, not only relative to the drop in fuel and energy prices a year ago, but of all consumer products that include petrochemical raw materials. The production economy had a lot to swallow this year, and not all companies immediately passed those costs on to consumers. So when consumers hear about cuts to oil production targets and the potential for higher prices, it’s very easy to mentally overlay that on the current rate of inflation and assume that it will continue to accelerate indefinitely, without take into account the disinflationary forces that have been at work. since summer.

Again, we believe it is an overstatement to extrapolate OPEC’s production target cuts to a spike in oil prices. Like all assets, oil changes according to supply and demand. As shown in Figure 2, supply has exceeded demand for a few months now, at around 1.3 million bpd in September. This figure is lower than OPEC’s supposed cut. It looks like the cartel is aiming to put a floor under recently falling prices. That might end the recent slump, but it doesn’t mean another spike, especially with consumption down from last fall’s peak when the world was gobbling up oil as an alternative fuel when European wind generation fell and coal was scarce in China.

Exhibit 2: The world has a surplus of oil

Source: FactSet, as of 03/10/2022. Global monthly oil supply and demand, January 2015 – September 2022. HT: Fisher Investments Research Analyst Ori Powers.

Also note that supply has increased (and prices have fallen) despite OPEC’s chronic failure to meet its targets. Yes, failure. According to a widely reported leak of some internal OPEC documents, OPEC and its partners (including Russia and others) missed the August production target of 3.58 million bpd.[ii] This is even worse than in July, when production was reported to have been 2.9 million bpd ahead of target due mainly to attacks on Nigeria’s oil infrastructure and production cuts from Russia following the sanctions, and that prolongs a long-standing failure. Reducing a target, which is being discussed, is very different from reducing actual production. On the contrary, it brings the target a little closer to where the production actually is, which makes the miss a little less embarrassing.

OPEC still gets the world’s attention, but it seems mostly a relic of the 1970s, when the cartel had real power to control supply. That was before the shale boom, when US production surged, leading to a global supply glut in the mid-2010s that took the world a few years to eliminate. It also took several years for US oil producers to overcome the overinvestment and debt accumulation of that era, which is one of the reasons they have been slower to grow this time around. But U.S. production is nonetheless on the rise, from a pandemic-era low of 9.7 million bpd in May 2020 to a post-pandemic high of 11.8 million in July, according to the latest available data.[iii] The American oil industry, unlike OPEC, does not operate by administrative decision. He lives in the private sector, even drilling on federal lands is far less subject to the whims of the government than the coverage on both sides of the political aisle suggests. With more than 100 national oil rigs this year so far, production likely continues to rise, potentially offsetting any real OPEC production cuts from here.[iv]

In our view, oil prices are not a fundamental driver of the stock market. Oil and stocks move simultaneously, as do all similar liquid assets, simultaneously digesting the same information. One does not predict the other. But oil prices have affected sentiment this year, so from that perspective, the decline in uncertainty in the oil world is likely to benefit equities as it gradually arrives. The more the world sees supply and demand remaining roughly balanced despite the rumblings of OPEC, the lower we should have this uncertainty.


[i] Source: FactSet, as of 03/10/2022. Price performance of the S&P 500 index on 03/10/2022.

[ii] “OPEC+ is now 3.6 million bpd below its oil production target”, Tsvetana Paraskova, OilPrice.com, 09/19/2022.

[iii] Source: US Energy Information Administration, as of 03/10/2022.

[iv] Source: FactSet, as of 03/10/2022.

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