The Impact of OPEC Announcements on Oil Prices
OPEC decisions have a small and fading impact on prices
By: Dan Rasmussen with Jeremiah Kim
OPEC recently announced a reduction in oil production of 2 million barrels per day, an almost 5% drop. President Joe Biden and other world leaders had been pushing the group to keep production high to help in the fight against inflation—and against Russia—and watched in horror as oil prices shot up in reaction to the news.
But how important are these OPEC announcements? And does the group really have the power to set the price of oil, a famously volatile commodity?
We looked at how oil futures prices responded to OPEC production cuts from 2015 to the present. We found, as shown in the graph below, that, while OPEC production cuts generally resulted in about a 5% increase in oil prices, prices faded quickly over the course of the week following the announcement.
Figure 1: Avg. Indexed WTI Front Month Futures Prices Surrounding OPEC Production Cut Announcements (2015–2022)
Source: Bloomberg, Verdad Analysis
We began our analysis in 2015 because the period prior to 2015 is well covered in the academic literature, and previous papers’ findings have been in line with the above.
From 1991 to 2015, announced production cuts tended to result in abnormal price returns for at least five days.
Figure 2: Cumulative Abnormal Returns (CAR) for WTI 5 Days Surrounding Quota Cut Announcement (1991–2015)
Source: Loutia, Mellios & Andriosopoulos (2016)
We reviewed an additional 20 papers on this topic and found general consensus on this short-term price impact, which is also in line with common sense.
Figure 3: Spot CAR 20 Days Surrounding OPEC Announcements by Type of Announcement
Source: Demirer & Kutan (2010)
The impact of production increases is less clear. Researchers found no statistically significant abnormal returns to oil prices following a quota increase. A quota maintenance announcement produced negative cumulative abnormal returns (CAR). Some researchers argue this is because the market is better able to predict quota increases versus other decisions. Moreover, market participants see production increases as less significant because of production "cheating" by OPEC member states regardless of quota levels. Lastly, announcing no change to existing quotas is interpreted by the market as a failure by OPEC to agree on a production cut, so prices adjust downward.
There is evidence that the market response to each respective quota decision depends on current oil prices. The effect of a quota announcement is larger when oil prices are low relative to their six-month or historical average versus when they are high. This is likely because high oil prices correspond with extended economic incentives for non-traditional sources of oil, such as arctic drilling. Therefore, the supply shock introduced by OPEC is less influential to the global market. Weak market conditions, like those during the pandemic or following the global financial crisis, are a caveat to this observation, where volatility in oil markets tends to eat into returns even after a production cut.
These studies suggest that quota cuts result in positive returns for long investors when prices are around their historical average. Returns are positive but less significant when prices are high, and returns are negative when market conditions are poor.
In sum, research suggests that announced OPEC production cuts drive abnormal positive returns for at least a few days, especially when prices are neither historically high nor low. Abnormal returns are likely mean reverting after 7–15 days. The literature has few studies that evaluate returns longer than 20 days post-announcement, so the observable time length of OPEC announcement effects remains unclear.
Acknowledgment: This piece was co-authored by Jeremiah Kim, a senior at Harvard studying math and government. Prior to interning with Verdad, Jeremiah interned at Credit Suisse. He will be working at Greenhill during summer 2023 and intends to work in banking after college. He is interested in philosophy, politics, and economics, and is considering eventually pursuing an MBA or Ph.D.