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Tsvetana Paraskova

Tsvetana Paraskova

Tsvetana is a writer for the U.S.-based Divergente LLC consulting firm with over a decade of experience writing for news outlets such as iNVEZZ and…

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Saudi Compliance To OPEC Deal Comes At A Price

OPEC

Saudi Arabia is following through with its pledge to stick to the output cuts in the OPEC/non-OPEC deal. The Kingdom is also reducing exports to some buyers, even to its most prized market—Asia.   

But this compliance comes at a price—Saudi Arabia has lost market share in Asia, with Russia, Angola and Iraq being the main beneficiaries.

At first glance, it may seem odd that Saudi Arabia is giving up some share of its beloved Asian market. But the Kingdom has two very sound reasons to stick to cuts, and to ‘motivate’ other members to do the same. Those two reasons are (a.) reducing the budget deficit and (b.) getting the highest valuation possible for Saudi Aramco before the IPO takes place in 2018. Saudi Arabia’s two main drivers actually come down to just one goal: achieve higher oil prices.

However, the Saudis face another dilemma—the higher the price of oil, the more they would be inadvertently helping U.S. shale drillers to produce more oil—at higher profit margins, no less.

So Saudi Arabia’s leading by example and putting a floor under oil prices is welcomed news for smaller U.S. shale firms, according to Forbes contributor Jim Collins.

Related: This Giant Oil Trader Sees Upside For Oil Prices

The Saudi-led OPEC efforts to ‘stabilize’ oil prices have recently started to pay off. The Brent futures curve flipped to backwardation, and global oversupply has nearly halved since the beginning of the year. Aided by strong demand growth in Asian economies, as well as robust demand in industrialized nations, global oil demand growth is stronger than expected.  

But the ‘fixing’ of the supply side comes at a high cost for Saudi Arabia. In August, the Kingdom spent a sixth consecutive month without the status of China’s top supplies, being outstripped by Russia and even Angola.

For now, it looks like Saudi Arabia is willing to sacrifice some market share in the short term in order to cut its budget deficit and aim for that coveted $2 trillion valuation of Aramco.

Saudi Arabia started posting deficits in 2014, and last year its fiscal deficit was 17.2 percent of GDP. It is expected to drop to 9.3 percent of GDP this year, and to just below 1 percent of GDP by 2022, according to the IMF. The Saudi Ministry of Finance plans to balance the budget by 2020.

For Aramco, a higher price of oil would help the company report stronger realized sales in the financial performance details that it must release ahead of the IPO.

The oil price target of Saudi Arabia—never officially set—has been around $60 per barrel for this year, a kind of a sweet spot that would have boosted economic growth without giving U.S. shale too much incentive to increase output too fast. Related: Next Week Could Be A Turning Point For The OPEC Output Deal

So far this year, WTI has averaged just below $50 per barrel. That’s off the Saudi target and right at the $50 threshold that many analysts believe U.S. shale needs to break even. Last week, Moody’s said in a report that U.S. oil producers need at least $50 to be able to see significant returns.

If the Saudis are determined to continue with their current policy to sacrifice market share in the name of higher oil prices, and if they manage to persuade fellow OPEC members and Russia to continue to act in concert at least until Aramco’s IPO and the rebalancing of the market, U.S. oil firms stand to benefit.

In the meantime, shale drillers may have to spend within their means in the world of $50 WTI oil.

By Tsvetana Paraskova for Oilprice.com

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