DTN Oil

WASHINGTON (DTN) -- New York Mercantile Exchange oil futures and Brent crude traded on the Intercontinental Exchange settled Monday's session sharply higher as market participants balanced their outlook for Saudi-led production cuts to significantly tighten the global oil market against weak demand fundamentals across developed countries that are struggling to contain high inflation and rising interest rates.

"Oil markets were already set to start tightening in the second half of the year with the potential for a substantial supply deficit building on China's demand rebound," said the International Energy Agency in response to OPEC+ production curbs.

Saudi-led coalition of 23 oil producers announced late Sunday a surprise 1.66 million barrels per day (bpd) in "voluntary adjustments" to their production levels beginning next month. The curbs will remain in effect until the end of the year. The output cut adds to a reduction of 2 million bpd agreed by the group in October. Taken together, the output cuts account for about 3% of the global oil production taken off the market in seven months.

Heading into this week's meeting, investors expected OPEC+ to keep production targets unchanged despite signs of fuel demand across Europe and the United States lagging. Supporting this view, U.S. manufacturing index released this morning showed nationwide industrial activity fell deeper into contraction last month, with headline index deteriorating to its lowest level since May 2020 when the economy was hit with COVID-19 lockdown.

"Regarding the overall economy, this figure indicates a fourth month of contraction after a 30-month period of expansion. Demand eased, with the New Orders Index contracting at a faster rate and New Export Orders Index still below 50% and declining," said the Institute of Supply Management when releasing the data.

The situation in Europe is not much better.

Manufacturing activity in Germany and France -- the bloc's two largest economies, fell to the lowest level in four months, reflecting weak customer spending and sluggish demand.

One could argue that OPEC+ cuts are preemptive in their nature as major economies expected to slow even further into the summer months. That is the view put forward by Saudi oil minister Abdulaziz bin Salman, who said the decision was aimed at stabilizing oil prices that have come under increased pressure from volatility in the financial markets as well as slowing global economy.

In a note released Sunday, Goldman Sachs argued that "OPEC+ still has very significant pricing power, and Monday's surprise cut is consistent with their new doctrine to act preemptively because they can without significant losses in market share."

Goldman boosted its Brent price forecast by $5 for December to $95 per barrel (bbl) and to $100 for December 2024.

On the flip side, the decision to cut oil production could further exacerbate inflation pressures that showed some signs of easing last month under pressure from the Federal Reserve's aggressive campaign in raising interest rates. The U.S. Personal Income and Consumption Index, the preferred inflation gauge of the Fed, showed prices paid for core services rose a less than expected 0.3% last month.

Consumer inflation across the U.S. has been cooling due to the sharp disinflation in the goods sector. However, sticky services inflation continued to keep consumer prices well above the Fed's 2% long-run target. According to the Fed's own forecasts, inflation in the U.S. will average 3.3% this year, up from 3.1% seen in December, and won't return to its target well until 2025. The OPEC+ decision to boost oil prices implies inflation may remain higher in the months ahead.

At settlement, the U.S. dollar index eased 0.39% against a basket of foreign currencies to 101.787, further spurring gains for West Texas Intermediate futures that jumped to $80.42 bbl, up $4.75. International crude benchmark Brent futures for June delivery advanced $5.04 bbl to $84.93 bbl. NYMEX May RBOB futures rallied $0.0765 to $2.7575 gallon, while May ULSD futures gained to $2.6626 gallon, up $0.0420.

Liubov Georges can be reached at liubov.georges@dtn.com