Saudi Arabia and its Gulf Arab neighbors and large fellow OPEC producers the United Arab Emirates (UAE) and Kuwait are discussing this week a potential joint oil production cut of 300,000 bpd in response to the depressed demand amid the coronavirus outbreak, taking a break from the OPEC+ alliance with Russia, The Wall Street Journal reported on Friday, quoting people with knowledge of the issue.
Saudi Arabia, the UAE, and Kuwait are the largest, third-largest and fourth-largest producers in the cartel, respectively, and they hold together more than half of OPEC’s production capacity.
The reported discussions about a three-way joint cut would be a break from the OPEC+ pact format with Russia, on which the Saudis have been relying for oil supply and price-fixing policies in the past four years.
Since the start of 2017, when OPEC and its Russia-led non-OPEC partners began their production cuts to prop up prices and erase the glut, OPEC’s leader Saudi Arabia have always acted in concert with Russia in the formal taking of decisions about production policies. So far, Russia has always been on board with the cuts, although it has always announced its position at the last possible moment.
However, the coronavirus outbreak that shattered oil demand seems to have fractured the Saudi-Russian alliance, and the partners have been at odds over how to respond to the slump in oil demand in the key oil growth market, China. Related: EIA Cuts 2020 Oil Demand Forecast By 378,000 Bpd
While Saudi Arabia has been pushing for deeper cuts in Q2 to cushion the blow to oil demand, Russia has been reluctant to cut deeper—it has taken time to review an OPEC+ group’s joint technical committee (JTC) proposal and has been avoiding for weeks now a direct reply.
On Thursday, Russia’s Energy Minister Alexander Novak dodged again a specific reply and reiterated that Russia hasn’t made a decision yet and continues to hold discussions with its partners.
Meanwhile, Saudi Energy Minister Prince Abdulaziz bin Salman, has reportedly compared the coronavirus impact on demand to a “house on fire,” Bloomberg reported this week, quoting anonymous sources who had heard the Saudi minister’s comments at an event closed to the press. When your house is on fire, “you can either treat it with a garden hose and risk losing the building, or call the fire brigade,” the minister reportedly said.
By Tsvetana Paraskova for Oilprice.com
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It is possible that Saudi Arabia may have persuaded its two neighbours to consider deepening of the existing cuts and they may have agreed as a gesture of solidarity with their big neighbour.
Saudi Arabia has been the most enthusiastic among OPEC+ members for a deepening of the cuts to stop oil prices declining further as a result of the coronavirus outbreak. However, its enthusiasm could most probably be motivated by two important factors.
The first is that a continued decline of oil prices could very adversely affect Saudi budget leading to a much bigger deficit and forcing the government to cut expenditure. After all Saudi Arabia needs oil prices far higher than $85 a barrel to balance its budget.
The second factor is to hide the continued natural decline in its oil production behind the cuts. Saudi oil production has been for years underpinned by five giant oilfields, namely, Ghawar, Safaniya, Khurais, Shaybah and Zuluf all of which are more than 70 years old and fast depleting. That is why Saudi Arabia has been over-complying by the production cuts. On balance, the more worrying factor for Saudi Arabia is the continued natural decline in its production.
Russia doesn’t see any benefit from deepening the cuts while the outbreak is still raging. That is why it has been dragging its feet vis-a-vis the Saudi call for deepening the cuts. Moreover, Russia's economy could live with an oil price of $40 a barrel or less compared with a far higher price than $85 for Saudi Arabia.
Still, oil prices have already risen to $59 a barrel since last week and have recouped part of their losses. It is possible they could rise to a range of $66-$69 in 2020 buoyed by a continued de-escalation of the trade war between the US and China.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London