OPEC production cuts to spur cleantech

OPEC production cuts to spur cleantech

The decision to cut oil production has major political and economic dimensions – and consequences. Clean-tech investments, however,display robust growth

The Organization of the Petroleum Exporting Countries and allied producers (OPEC+) last week surprised the market with the announcement of a major cut in their oil production starting May this year. Saudi Arabia and other producers will make voluntary cuts of 1.16 million barrels per day (bpd), joining Russia’s current cut of 500,000bpd. The cuts are set to last through the end of this year, barring future adjustments.

This sent Brent futures prices soaring almost 20% to peak since then, hitting almost $82 a barrel – something it hadn’t done since January this year. Concurrently, several global banks including Goldman Sachs too increased their end-2023 forecast for Brent by $5 to $95 a barrel, while that for end-2024 was also raised to $100/barrel.

Image: NYMEX Light Sweet Crude Oil (WTI) Electronic Energy Futures Pricing; Source: Refinitiv

OPEC+ worried about recession

In the past year, soaring energy prices and Russia’s invasion of Ukraine had been substantial accelerants to global inflation, though that effect had been minimised of late. The most recently announced cuts thus makes a compelling case for a concerted global transition away from dirty fuels. Yet, on the contrary, even as experts repeatedly underscore the severe downsides of relying on commodities controlled by a handful of countries, the sudden crunch in supply coupled with the jump in futures trades has pushed even the most climate-progressive nations to turn to coal and gas as a backup for their immediate short-term needs.

The announcement for a cut suggests the major concern for OPEC+ remains worries of an oncoming recession by the end of this year. With central banks around the world fighting several-decade-high inflation in their respective economies by hiking key policy interest rates and global bond markets showing inverted 2y–10y curves for over three quarters, the very real threat of recession looms just around the corner. This would imply a considerable slowdown in demand by end-2023 and early the next, and is a factor surely weighing on the minds of the middle-eastern oil barons.

It is hard to envision a strong second-half increase in global demand without a big uptick in China, which so far has underwhelmed in economic activity since its December 2022 reopening from the COVID-induced mass lockdowns of their major ports and cities. If the country delivers anywhere near the 960,000 b/d in demand growth that the International Energy Agency anticipates, it may well create a tighter crude oil market. This would then likely provide a strong policy push for leadership in clean tech and Europe’s fast-developing response creating near-term and strategic investment opportunities.

Yet another factor that OPEC+ has shown concerns over is the global dependence on the United States, the world’s largest oil producing nation, and the use of the dollar for the majority of global transactions. They have repeatedly outlined their goal of moving away from dollar-denominated trade and towards the creation of a separate bloc at the heart of which would lie tie-ups with Russia and China.

Clean-tech investments show robust growth

On the brighter side, climate investing as a whole has experienced a period of breakout growth in capital formation over the past four years. From 2019 until the end of 2022, global private equity investors have launched more than 330 new sustainability: environmental, social, and governance (ESG) and impact funds. The cumulative assets under management in these funds grew threefold, from $90 billion to more than $270 billion.

The US Inflation Reduction Act (IRA) passed in August last year allocated more than $370 billion in funding to mitigate climate change, unleashing a slew of production incentives in areas tied to the transition to lower carbon emissions. The European Union (EU) Green Deal Industrial Plan (GDIP) too could potentially dedicate over €1 trillion in public and private funds towards the fight, as they aim to speed up deployment of funds to build cleantech at home, driven by a search for energy security and competitiveness. Together, these measures may open up more opportunities for investors in a market that McKinsey estimates could reach almost $12 trillion in annual investment by 2030.

The EU GDIP aims to boost European manufacturing of key transition technologies via domestic production targets, provide easier access to funding and fast-track permitting. An expanded carbon pricing program too encourages EU firms to expedite transition plans, with the price of carbon recently passing €100 per tonne. Also noteworthy is that an estimated $400 billion of the GDIP remains unspent.

Western policy initiatives are about getting a slice of the growing clean-tech pie and reducing reliance on China for minerals and metals needed for the transition, in our view. We see this as the start of a clean energy race as countries rush to adopt similar policies – a strategic priority against a backdrop of growing geopolitical fragmentation. The UK, Canada and Australia are all set to jump in, and this race fits with the view that the transition is likely to accelerate.

The decision to cut production has both political and economic dimensions –and perhaps, consequences. As the Financial Times noted in a recent story, which quickly led its website to headline: “Initiative to boost prices shows Saudi Arabia’s determination to pursue different energy strategy to Washington.”

Further pressure on Indian inflation and trade deficit

For India the OPEC+ move will have an adverse impact on their trade deficit. India’s crude oil import bill nearly doubled to US$119 billion in the fiscal year that ended on March 31, 2022. Every $10 per barrel rise in crude oil price will increase India’s import bill by $15 billion annually. This is only set to add to further pressure on its domestic inflation, which has continued to remain sticky over the RBI’s upper limit of 6% for a considerable period.

India’s total crude oil imports –mainly from the OPEC+ and Africa –was 71.6% in fiscal 2022 and 71.9% in fiscal 2021, according to data from Reuters. This is expected to be lower for the previous fiscal with the increase in imports from Russia after the European Union put a cap on Russian crude oil at $60 per barrel.

In October last year, Russia surpassed traditional sellers like Iraq and Saudi Arabia for the first time to take the number one spot. Russia, which previously accounted for just 0.2% of India’s crude oil imports, supplied 1.19 million bpd last December – accounting for about 25% of India’s total crude oil imports in 2021–22. The December figure was considerably higher than the 9,09,403 bpd of crude oil India imported from Russia in November and the 9,35,556 bpd it imported in October, according to data from Vortexa Ltd.

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