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Saudi Arabia’s solo oil production cut is risky - Javier Blas

Tan KW
Publish date: Wed, 07 Jun 2023, 07:57 AM
Tan KW
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FOR years, Saudi Arabia has vowed to intervene in the oil market only in concert with the Organisation of the Petroleum Exporting Countries bigwigs - and rarely, if ever, alone.

Call it the oil version of “all for one, one for all.” Riyadh threw away its own rule book, announcing a unilateral output cut that would push the country’s production down to levels rarely seen in the last decade.

The market reaction? Meh.

Oil rose a lacklustre 2% in early trading on Monday, with Brent still below US$80 a barrel.

Few Saudi officials understand better than Prince Abdulaziz bin Salman the “never alone” mantra. The current Saudi oil minister attended his first meeting of Opec in 1987. It was a teaching moment for the young royal.

For several years, Riyadh had cut oil production unilaterally to support prices, ceding market share to rivals inside and outside Opec.

At one point in late 1985, with output barely covering domestic consumption, the kingdom threw in the towel and sharply boosted output, triggering a price collapse.

So, why has Prince Abdulaziz, a critic of previous Saudi ministers who acted alone, taken the solo route?

On Sunday, Riyadh announced it will reduce output by 10% in July. Coming on top of cuts in May and June, which only included a handful of Opec nations rather than the whole group, it would reduce Saudi output to nine million barrels a day.

Excluding a period during the Covid-19 pandemic, when demand plunged, Saudi oil output would drop to a level unseen in more than a decade. Riyadh regularly pumped more than nine million barrels a day in 2003, and again from 2005 to 2008.

The cut is meant to be only for July, but the Saudis indicated it may be extended if needed. Oil traders reckoned that’s likely.

Prince Abdulaziz said the cut highlighted how the kingdom “will do whatever is necessary to bring stability to this market.” For stability, read higher oil prices.

Because Riyadh is forfeiting so much production, unless prices rally over the next few days it would end giving up an enormous amount of petroleum revenue.

Everyone else inside the Opec+ alliance would reap the benefits.

To keep earnings unchanged, Riyadh needs oil to surge by more than US$10 a barrel to offset the drop in production from April to July.

It’s impossible to know what would have happened to oil prices had the Saudis kept output unchanged. But for now, it doesn’t look like the strategy is paying off.

Still, if one accepted the Saudi narrative, the cut is the oil market equivalent to “shock-and-awe” in modern warfare.

It will rapidly tighten a market that was about to get tighter anyway thanks to seasonally rising oil demand.

Using the supply-and-demand balances published by the International Energy Agency, the oil market may be undersupplied by more than 1.5 million barrels a day during the second half of the year.

That’s a huge gap that requires higher prices. Also, because Riyadh doesn’t cheat on its oil-output pledges, as others in Opec do, the impact of the extra cuts would be truly felt in the physical petroleum market. Over time, the physical market tightness will spread into the world of financial contracts in Wall Street, flushing out speculators.

Taking a sympathetic view, the cut by Prince Abdulaziz is bullish, perhaps marking a first step to drive oil prices back to the US$90 to US$100 range the Saudis prefer.

Unlike in the 1980s, the Saudis don’t face massive competition. Back then, oil production was gushing everywhere.

Now, even the United States shale industry is somewhat on the back foot, and Russia isn’t in a position to increase production either.

But there’s a far less rosy view. The sceptical perspective said the Opec weekend didn’t go Saudi Arabia’s way, and Prince Abdulaziz was, effectively, forced into a solo cut.

Since Riyadh roped Russia into the cartel in 2006, it was meant that both countries would cut in unison.

Over the weekend, no deeper output reductions were pledged by Moscow, which instead simply extended the length of curbs previously announced.

Moreover, many inside Opec were sceptical, to put it mildly, that the Russians were even delivering on those supply promises.

And with the United Arab Emirates winning an increase in its quota for 2024, that nation will soon be adding oil into the market, irrespective of what the Saudis do.

The dichotomy of Saudi Arabia cutting output to a 10-year low while its neighbour prepares to open the taps is telling.

Put together, both measures indicate that Moscow and Abu Dhabi are more content with lower oil prices than Riyadh is. Both are vocal enough to get their way, too.

If that’s true, Saudi Arabia could be forced to shoulder more of the weight of managing the oil market alone if it wants to keep prices elevated - much as it had to do in the 1980s.

It’s a high-reward but extremely high-risk strategy. The Saudis are hoping their unilateral cut will be short-lived, and soon the market would tighten enough to require more of their oil.

That was the bet, too, in the 1980s. Back then, the strategy failed spectacularly.

Hopefully for Prince Abdulaziz, the lessons learnt may mean he succeeds where his predecessors stumbled.

 - Bloomberg



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