From casual observation, one might be forgiven for referring to the OPEC production cut in place since November 2016 as the “Saudi production cut.” That’s because Saudi Arabia, OPEC’s leading producer and de facto leader, has reduced its crude production by the biggest margin, shouldering the bulk of the burden for the rest of OPEC and striving the hardest to bring prices back up.
But how long will Riyadh choose to maintain this strategy? Saudi energy minister Khalid al-Falih said definitively that his country will abide no “free riders” hoping to take advantage of Saudi cuts to ramp up their own production, as OPEC and non-OPEC producers did in the 1980s. It now seems possible that OPEC may agree on an extension of the production cuts past June 2017, but with its own agenda and an eye towards an “oil-less” future, Saudi Arabia may choose to pull back from its over-exertions on behalf of world oil markets and look after its own interests.
Analysis found that Saudi cuts were actually deeper than the OPEC deal had stipulated. In February, Riyadh reported that it cut 717,600 bpd, bringing production down to 9.748 million bpd, which was more than 300,000 bpd below the limit specified by the OPEC deal. Reported cuts in January totaled 3.8 percent of OPEC output, and Saud exports fell to 7.7 million bpd.
In the aftermath of the deal, WTI and Brent shot up and confidence in long-term price outlooks were boosted. Yet bullish gave way to bearish in March when high inventories and signs of a resurgent U.S. shale sector sent prices down ten percent.
Events in Libya, including the imminent re-opening of a major oil port, as well as the increasing U.S. rig count indicates that the initial effect of the OPEC deal has worn off. On March 16 Al-Falih said that OPEC would extend cuts past June to return prices above their five-year average.
Related: Venezuela In Dire Straits As Oil Production Falls Further
But realistically, for that to happen, Saudi cuts will have to deepen. This will hurt the country’s financial situation. In 2015 the official budget deficit was $98 billion, though cuts to infrastructure projects, slashed salaries, wage freezes and the introduction of new taxes, including the Persian Gulf’s first value-added tax, brought the deficit down to $79 billion in 2016.
Major moves towards austerity were slowed in the 2017 budget, which called for increased spending, including 268 billion rials, or $71 billion, on the National Transformation Plan through 2020. The budget deficit is expected to fall 33 percent on the back of higher oil prices, which are expected to average above $50.
To reach these goals, Saudi oil revenues have to remain high, even as the country plans to wean itself off of oil as the major foundation of its economy. In 2016 oil accounted for 62 percent of government revenues, while in 2017 it’s expected to account for 69 percent, according to Bloomberg.
Saudi losses from the two-year “war” over market share with U.S. producers has cut into its once-dominant market position. Saudi imports to the U.S., formerly its largest export market, have declined to around 30,000 barrels per month, from over 50,000 barrels per month in April 2014 according to EIA data. Responding to this decline in Western Hemisphere import demand, Riyadh is planning to ramp up exports to China, its second largest export market. A visit by King Salman to Beijing this week was a step towards solidifying Saudi-Chinese cooperation in energy matters.
While fighting off shale in the West, Riyadh has had to contend with Russia in the East. Russian output exceeded that of Saudi Arabia in January, exceeding 11 million bpd and reaching its highest level in thirty years. After lagging behind Saudi Arabia for years, Russia now ties it for 14 percent of the Chinese crude oil market, according to data compiled by Bloomberg.
Russia has vowed to cut production by 300,000 bpd by April as part of its agreement with OPEC, but it has nevertheless taken the opportunity to horn into Saudi markets in recent years, placing additional pressure on Riyadh. Related: The Upcoming Surge In U.S. Oil Demand Explained In One Chart
Then there is Vision 2030, the long-term plan to redirect the Saudi economy. Also known as the National Transformation Plan, the project calls for a sale of Saudi oil and gas assets, including the massive state-owned Saudi Aramco. Boisterous claims that the company was worth $2 trillion have been tempered in the last few months, with analysts suggesting the company could be worth anywhere from $400 billion to $1 trillion. If Saudi market share continues to drop, or if prices continue to stagnate past 2017 into next year, when the first 5 percent of Saudi Aramco will be offered, it could seriously affect the Saudi government’s ability to realize gains from the company’s IPO. Nobody wants a trillion-dollar oil company if there are no markets to go with it.
Given the relative strength of the Saudi position, as well as confidence that prices will recover this year despite a surge in U.S. shale, it looks likely that Riyadh will choose to double-down on the production deal and extend it past June. But that depends on getting the rest of OPEC to cooperate. That includes a recalcitrant Iran, a rebellious Iraq, an unstable Libya and a broke Venezuela. The OPEC leader doesn’t want any more “free riders,” and with compliance among members high, it looks like it’s getting its wish. But this is unlikely to last for long, and once it ends, the Saudis may not be willing to pick up the slack.
By Gregory Brew for Oilprice.com
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