The oil producers’ group presents its decisions in terms of balancing production and consumption, but its actions reveal a preference for lower inventories and higher prices
Senior officials from Opec and allies have offered a variety of explanations for last week’s decision to reduce their collective production target.
Some of these arguments are stronger than others. But the idea of holding some capacity in reserve so output can be increased during some future emergency is based on faulty logic, especially when inventories are already low. US petroleum inventories including the strategic reserve have depleted in 86 of the past 118 weeks by a total of 480-million barrels and are at the lowest seasonal level since 2004.
Inventories have fallen so low they can no longer play much of a role as shock absorbers in the event of stronger than expected consumption or a sudden loss in production.The extreme backwardation in Brent futures is a symptom of global petroleum inventories becoming uncomfortably low. If put into production, extra capacity can accumulate a stock of extra petroleum inventories over multiple months, whereas in the aftermath of a shock it can only supply a much smaller increase in daily flows.
In the event that the global economy avoids a recession, China’s growth accelerates, or there is a major interruption to Russian oil supplies, inventories will be too low to respond and it will be too late to rebuild them.The proactive production cuts announced last week stand in contrast to the second quarter of this year when inventories were falling and prices rising rapidly.
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