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Tsvetana Paraskova

Tsvetana Paraskova

Tsvetana is a writer for Oilprice.com with over a decade of experience writing for news outlets such as iNVEZZ and SeeNews. 

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Was Saudi Arabia's Surprise Production Cut A Good Idea?

Oil prices have risen by 10 percent since the end of 2020 and 8 percent since the OPEC+ meeting two weeks ago, but the rally has nothing to do with the short-term oil demand outlook. It has been almost exclusively due to the decision of Saudi Arabia—the world’s top oil exporter and OPEC’s de facto leader—to cut an additional 1 million barrels per day (bpd) from its production in the first quarter.

Saudi Arabia, as well as major forecasters, expected oil demand in Q1 to continue to struggle as major economies in Europe and now parts of China are under renewed lockdowns to fight the spread of COVID-19.   

“Wonderful Surprise”

The Kingdom’s “wonderful surprise” to the oil industry, as its Energy Minister Prince Abdulaziz bin Salman described the extra cut in a Bloomberg interview, lent support to oil prices while the outlook for Q1 demand continues to deteriorate, due to the spreading virus, strict lockdowns, and a slow start to vaccination programs.    

The Saudi ‘generosity’ signals that the Kingdom is willing to forgo short-term market share in order to prop up prices amid weak immediate demand, tighten the market faster, and wait for the opportunity to ramp up production once oil demand rebounds at some point in the second half of 2021. Yet, in the process, the Saudis could incentivize increased activity in the U.S. shale patch, which could abandon the promised restraint in spending, and increase production. Higher-than-currently-estimated U.S. oil supply could cap oil price gains and ruin the Saudi attempts to over-tighten the market.

The Saudi cut also signals growing divergence in oil-price fixing policies between the two leaders of the OPEC+ pact, Saudi Arabia and Russia. Saudi Arabia looks more eager to see higher oil prices, even at the expense of losing more market share to U.S. shale. Russia, which had pushed for another 500,000-bpd collective production increase from OPEC+ in February, has been wary for years that by cutting its own production and helping to support prices, it is actually boosting U.S. oil output.  

Weak Q1 Oil Demand  

Considering that the International Energy Agency (IEA) yet again cut its outlook on global oil demand for 2021, including revising down its Q1 demand projection by 600,000 bpd, Saudi Arabia seems to have made the right call when it announced the extra 1-million-bpd cut to its production for February and March. Related: Oil Majors Are Eyeing A Suriname Offshore Boom

In terms of achieving higher oil prices and a tighter market going into the second half of 2021, the Saudi move looks right.

According to the IEA’s monthly report from this week, the OPEC+ group’s “more proactive production restraint looks set to hasten a drawdown in the global stock surplus.”

“Assuming OPEC+ achieves 100% compliance with the latest agreement, global oil stocks could draw by 1.1 mb/d, or 100 mb, in 1Q21, with the potential for much steeper declines during the second half of the year as demand strengthens,” the agency said.

But while Saudi Arabia’s energy minister says, “We are the guardian of this industry,” the Kingdom is (maybe inadvertently) helping U.S. shale by ‘guarding’ the price of oil from collapsing when demand is weak, as it is this quarter.

Saudi Success Could Hinge On Shale’s Response To The “Wonderful Surprise”

Analysts, including OPEC and the IEA, say that the higher oil prices—thanks to Saudi Arabia—could provide a reason to the U.S. shale patch to boost drilling activity more than anticipated earlier.

The “wonderful” Saudi gift to support the oil market could hinge on U.S. oil producers resisting the temptation to increase production after WTI Crude prices hit this month the $50 a barrel mark for the first time since February 2020.  

U.S. firms “seem committed to pledges made to keep production flat and instead use any price gain to pay down debt or to boost investor returns. If they stick to those plans, OPEC+ may start to reclaim the market share it has steadily lost to the US and others since 2016,” the IEA said in its latest Oil Market Report. Related: Biden Plans To Kill Keystone XL Oil Pipeline

Oil above $50 is set to create a chain reaction in the U.S shale patch, which could see cash from operations (CFO) rise by 32 percent this year, Rystad Energy says. Shale producers in the Permian Midland, Permian Delaware, Eagle Ford, Bakken, and DJ basins could see their combined CFO increase to $73.6 billion in 2021, up from an estimated $55.7 billion in 2020, but still down from $87 billion in 2019.

Nevertheless, WTI Crude averaging above $50 and the higher cash flow in the shale industry would allow producers to increase their activity spending, according to Rystad Energy.

Granted, higher activity in the shale patch will be necessary just to keep U.S. production flat, but the $50-plus oil price could be tempting. Wood Mackenzie expects a cautious ramp-up of activity, with shale oil production continuing to decline into the second half of 2021.

“Yet despite all the compelling arguments for restraint, the industry’s history suggests that increased cash flows generally get turned very quickly into new wells,” Ed Crooks, Vice-Chair Americas at Wood Mackenzie, said last week. 

By Tsvetana Paraskova for Oilprice.com

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