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Irina Slav

Irina Slav

Irina is a writer for the U.S.-based Divergente LLC consulting firm with over a decade of experience writing on the oil and gas industry.

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The Saudi Dilemma: To Cut Or Not To Cut

To cut and push up prices or not to cut and preserve market share, this is the question that Saudi Arabia is facing ahead of this year’s December OPEC meeting. It seems like just yesterday when OPEC met in 2016 and decided to cut production by 1.8 million barrels daily, including from Russia, to reverse the free fall of oil prices. At the time, it worked because everyone was desperate. Now, many OPEC members are both desperate while not yet recovered from the 2014 blow. Saudi Arabia is not an exception.

A recent report from Capital Economics said Saudi Arabia has its problems but it could withstand lower oil prices without feeling too much of a pinch. "Even if [Brent] prices fall further to $40-$50 a barrel, immediate balance of payments strains are unlikely to emerge," the report said, with its authors adding the Kingdom would be able to finance its trade deficit from its foreign exchange reserves “for at least a decade.”

This suggestion is not universally accepted. Reuters’ John Kemp this week offered a different perspective in his regular column on oil, noting Saudi Arabia’s foreign exchange reserves currently stand at US$500 billion, down from nearly US$750 billion in 2014 when the oil prices slumped under the weight of U.S. shale oil. At the same time, Saudi Arabia is in a major push to diversify its revenue streams and has committed a lot of money to it.

Also, Kemp wrote, “The kingdom probably needs to keep several hundred billion dollars’ worth of reserve assets on hand to maintain confidence in its fixed exchange-rate peg to the U.S. dollar and prevent a run on the currency.”

It’s a classic rock and a hard place situation for the Saudis. On the one hand, they could continue pumping at the current record rate or close to it, pressuring prices further, which is what they did in 2014. That strategy hurt U.S. shale substantially, but the attempted assault did not go quite as planned. Now, it will once again hurt U.S. shale, but again, it won’t beat the resilience of the US shale patch.  That much should have become clear in the past three years.

Related: Saudi Oil Output Hits Record High In November

On the other hand, Saudi Arabia could start cutting, but it will need to convince all other OPEC members to join the cuts and, more importantly, Russia. Reuters earlier today reported, quoting unnamed sources, that Russia had “accepted the need to cut production” and prices immediately jumped, once again highlighting how important the Russia-Saudi Arabia cooperation has become for oil markets, if it even needs highlighting.

For now, it seems like a cut is the more likely outcome. In spite of reservations expressed by Nigeria and Libya, if Saudi Arabia managed to convince everyone to cut amid the major tensions with Iran ahead of the U.S. sanctions, then it could probably convince them again, if only on the grounds that if they don’t start cutting all will suffer.

Kemp agrees. “Saudi Arabia cannot afford another slump in oil prices,” he warns. “It needs to keep revenues high to help its economy climb out of recession and finance ambitious social and economic transformation programs.”

Yet the Kingdom is preparing. Kpler reported this week loadings of Saudi crude since the start of November had reached new highs of 8.14 million bpd, which was 770,000 bpd more than the average daily loadings rate for October and much higher than the last 2018 high of 7.766 million bpd booked for June. The bulk of the increase comes from China, with shipments in that direction up by more than half a million barrels daily in November from October. Production is also at record highs, like Russia’s was ahead of the first cuts in 2016. Perhaps we are seeing a lesson learned there or perhaps the Kingdom is out of options besides cutting.

By Irina Slav for Oilprice.com

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  • Mamdouh G Salameh on December 03 2018 said:
    It is a big probability that a cut in OPEC production will be agreed in the December meeting in Vienna. But who will be doing the cutting?

    The overwhelming OPEC members could be against any new cuts. Instead, they will demand that Saudi Arabia and Russia withdraw the 650,000 barrels a day (b/d) they jointly added to the market in June against OPEC members’ wishes and return them to the original 1.8 million barrels a day (mbd) cut under the OPEC/non-OPEC agreement. In so doing, the glut in the market will ease.

    Saudi Arabia finds itself being pulled in opposite directions. One direction is not to cut production as President Trump is demanding having lost a lot of leverage with the United States as a result of the shielding provided to it by the Trump administration in the aftermath of the murder of the Saudi journalist. But this is not an option for Saudi Arabia as it needs an oil price above $80 a barrel to balance the budget.

    The other direction is to therefore to try to persuade OPEC members to cut production. However, Saudi Arabia’s oil minister Khalid al-Falih has been saying that his country will not cut production without a collective decision from the OPEC+ members. But then he should have consulted them before he succumbed to President Trump’s pressure on his country and raised oil production in collaboration with Russia in June against the wishes of the overwhelming majority of OPEC members. The Saudis sacrificed then their national interests and those of the OPEC members to please President Trump.

    Were the Saudis to decide not to cut production and to continue to produce at current levels, oil prices could decline further and they will be in a worse mess than the one they faced after their decision to flood the global oil market in the aftermath of the 2014 oil price crash. Their decision then failed miserably and inflicted huge damage on the Saudi economy and the economies of OPEC members. So this is not an option as Saudi foreign exchange reserves have fallen from $750 bn in 2014 to an estimated $500 now. These will be needed to defend the Saudi currency against devaluation.

    Saudi Arabia will most probably end up doing most of the cutting on its own with symbolic cut from Russia which is lukewarm about a new cut but will do a small one to show solidarity with Saudi Arabia.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London

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