When back in July Saudi Arabia announced voluntary additional oil production cuts, traders brushed them off. Prices did not move. Everyone was preoccupied with demand in China and the U.S. Three months later, things look very different. The Saudis and Russians announced a three-month extension to their combined cuts. Forecasters turned their attention toward supply. As it turns out, supply was already tight due to strong demand, which only aggravated the imbalance.
If only someone could have seen this coming.
Only many could see this coming. First, both Saudi Arabia and Russia needed higher oil prices. Second, unlike previous times when OPEC+ cut production to boost prices, the risk of U.S. shale responding with a surge in production was low. U.S. shale is enjoying its new, more disciplined approach to production growth and taking it slowly rather than rushing to add rigs every time WTI goes up by a dollar.
In this particular case, there is one more reason nobody is rushing to the rigs: U.S. drillers are still dealing with substantial cost inflation and expect it to continue into next year as well, the Dallas Fed Energy Survey revealed this week.
So, with the main challenge of U.S. shale stepping up and filling the gap left by those 1.3 million barrels daily gone, Saudi and Russia essentially had a sure bet.
Related: Analysts Raise Oil Price Forecasts As Market Tightens
Saudi Arabia’s oil revenues could be $30 million a day higher this quarter than the last one, according to Energy Aspects analysis quoted by the Wall Street Journal. That’s a 5.7% increase over the second quarter—or an additional $2.6 billion.
Russia could see oil revenues expand by $2.8 billion over the period, the report also said. Reuters separately calculated that Russia’s oil—and gas—revenues for September alone could reach $7.6 billion, which would be 14% higher than revenues for August.
The WSJ report referred to Saudi Arabia’s and Russia’s move as risky. Under other circumstances, it may have been. When a producer reduces its supply, another one usually steps in to fill the vacuum. Or the cuts simply fail to move prices, which is what happened with the Saudis in July. But then things changed.
As already noted, no other producer could step in and fill the vacuum left by Saudi and Russian oil. No one did. And despite a slight delay, the cuts did their job: they pushed prices higher and are still pushing them higher. Because of demand.
The last two weeks saw two updates from the International Energy Agency on the issue of oil demand. The first, a teaser for its World Energy Outlook, said that oil demand would peak before 2030. Gas and coal demand would peak, too, their fates written by their replacements, wind, solar, and EVs.
That was two weeks ago. This week, the International Energy Agency published the updated version of its Roadmap to Net Zero, in which it said that oil demand must drop by about a third by 2030. In other words, it was not going to decline all by itself, but it had to if the world was to stick to the net-zero path.
The IEA messaging was not welcomed by oil producers, Saudi Arabia included. The Kingdom has been repeatedly warning that there was not enough investment in new oil and gas supply, and messages like the IEA’s risked an even lower appetite for investments, which would jeopardize supply security.
Indeed, soon after the first update on oil demand that the IEA’s Fatih Birol published in the FT, JP Morgan’s head of energy equity research, Chrystian Malek, forecast a volatile supercycle for hydrocarbons, with $150 per barrel not out of the question for crude. What’s more, he said the supercycle could keep oil prices above $100 until the end of the decade because of short supply.
Forecasting peak oil demand and saying it must peak, then, is not enough to lower prices. That’s the job of actual demand, which tends to start declining when prices get too high. The only question, therefore, is what price is too high.
“I think you need to see crude oil prices at $100 to $110 per barrel with gasoline prices rising to $4.00 to $4.25 per gallon to have the consumer change their driving habits resulting in demand destruction. We do believe that there will be substantial demand destruction at WTI prices above $95 per barrel, which will drive the commodity back into our fair value range,” Andy Lipow from Lipow Oil Associates told Yahoo News this month.
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However, this is not universal. It may not even be really true. When people need to drive, they will drive, whatever the price of a gallon of gasoline. India is a case in point. Despite rising prices, demand for oil in India has been on the rise, too, even as forecasters predicted a slowdown in the second half of the year.
It is also expected to rise further as the festive season begins in the final months of the year, and next year as well, regardless of where prices are going, it seems.
The Saudis and the Russians may have taken a risk with their cuts, but it was a measured and modest risk. The resilience of oil demand continues to guarantee the success of such moves, with the only question that really matters being at what point does demand begin to get eroded by high prices?
By Irina Slav for Oilprice.com
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When the Saudi cut was announced in June, I was the only expert who said that the cut has nothing to do with market and prices and everything to do with Saudi production difficulties. I never wavered in my view.
I even said that the cut will give Saudi Arabia time to replenish its inventory of stored oil since my estimate of Saudi production is 6.5-7.0 mbd with 3.0-3.5 mbd coming from stored oil to make up the 10.0 mbd that the Saudis declare as their production.
My rationale is based on the undeniable fact that 90% of Saudi production has for the last 70 years been coming from five giant fast-depleting and aging oilfields (Ghawar, Safaniya, Hanifa, Khurais and Zuluf) all of which are more than 73 years old and are being kept producing by an injection of billions of barrels of water.
By 2030 I project that Saudi Arabia could be left with an estimated 120,000-400,000 barrels a day (b/d) to export at which time it would have virtually ceased as an oil exporter.
At the time of the cut, crude oil prices were starting to recover after fears of a global banking or financial crisis reminiscent of the 2008 crisis in the aftermath of the collapse of three US banks, subsided. Therefore, anyone thinking that the Saudi and Russian cuts have had anything to do with prices is, in my opinion, missing the point. The Russian cut was a mere gesture of solidarity with Saudi Arabia.
Prices have been surging because of robust oil demand, tightening market, record-breaking Chinese crude imports and indications of an impending imbalance in the market. Against such powerful bullish factors, it is safe to assume that we will soon see $100 oil.
These bullish factors were being bolstered further by indications that neither OPEC+ nor non-OPEC producers are in a position to raise production sufficiently enough to offset expected shortages.
Even at a Brent crude price of $100-$110, there will hardly be a demand destruction. It is true that demand might slow down a bit initially but within a week it will resume at full blast. The reason is that the world uses oil not out of love but our of a quint essential necessity.
Dr Mamdouh G Salameh
International Oil Economist
Global Energy Expert