When earlier this week reports emerged that Saudi Arabia is striving to keep oil prices in the range of US$70-80 per barrel in a bid to balance its need for higher prices with President Trump’s insistence that oil is kept within reasonable bounds, few must have been surprised.
OPEC’s leader and passionate supporter of Trump’s policy towards Iran had few useful moves in an environment featuring fast-rising prices and unhappy consumers from India to the States. It found itself between the rock of high prices, necessary for the Kingdom to pursue the widely advertised economic reforms under its Vision 2030 program, and the hard place of its closest ally’s own agenda, which unsurprisingly involved lower prices at the pump ahead of the midterm elections this November.
According to some, the hard place will disappear after the midterm elections. S&P Global Platts senior writer on oil Herman Wang is among them. In a recent analysis, Wang wrote that Trump’s pressure on Riyadh to keep a cap on prices could dissipate after the elections, potentially offering Saudi Arabia the freedom to adjust its production any way it sees fit to get to a more desirable price level.
Yet the extent of this freedom remains an open question: Wang notes that the midterm elections are a day after the entry into effect of the second round of U.S. sanctions against Iran, and additional supply will need to be provided to soften the blow. Trump has already authorized the sale of 11 million barrels from the Strategic Petroleum Reserve in November, but this will not be enough: S&P Platts analysts estimate the sanctions could take 1.4 million bpd of Iranian crude off the global market. Someone else will have to step in and pump more if prices are to stay within the current range.
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For most, this someone is Saudi Arabia. It is the largest OPEC producer and the OPEC member with the largest spare capacity. There is one problem with this, however: some observers have questioned the size of this capacity. According to S&P Global Platts, the Saudis have 1.7 million bpd of spare production capacity, an estimate based on Platts’ July survey, but some analysts doubt that Saudi Arabia’s spare capacity is that high.
In July, Reuters polled several analysts on the topic and got some quite enlightening responses to the question of whether Saudi Arabia can cover all lost Iranian supply after the sanctions, as Energy Minister Khalid al-Falih said in June.
Some, such as Energy Aspects’ chief oil analyst Amrita Sen said that “While Saudi Arabia has the capacity in theory, it takes time and money to bring these barrels online, possibly up to 1 year.”
Others, namely Gary Ross, who is head of global oil analytics at S7P Global Platts, said, “The Saudis do not have 2 million bpd of spare capacity as it would imply production of 12 million bpd. They can likely produce a maximum of 11 million and even that will be running their system at stress levels.”
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Saxon Bank’s Ole Hansen said the only way the Saudis could increase their supply was by tapping their reserves—something which we saw in August, when production in the Kingdom was lower than supply from the Kingdom. In short, analysts are skeptical about the ability of Saudi Arabia to up supply quickly and sufficiently to help prices remain stable.
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The bigger question is whether Saudi Arabia would want to do this. If Platts’ Wang is right and Trump lets go after the midterm elections, the Saudis would have their hands untied to keep production at whatever levels they want and sit and watch Brent climb above US$80 and even above US$90 as some analysts already forecast.
Unfortunately for Riyadh, this price level will only last a short while before it hits demand in the biggest consumers. India and China will not swallow Brent at US$90 readily. They might up their supply from Iran—an idea that is probably causing physical pain in some heads in Riyadh—or take in more Russian and U.S. oil. The shortest summary of the Saudi situation right now has to do with eating their cakes and having it too.
By Irina Slav for Oilprice.com
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The US oil industry appears to act along the lines of a rabies infected Canis that sees red and cannot do anything but bite given the opportunity. It's reasonably certain that the Saudis know this so feeding that particular beast is probably not their preferred position regardless of other externalities.
It is interesting that the range is 70-80, one would assume Saudi Arabia and OPEC in general could be profitable at a lower range and would seek to keep more pressure on the US output, maybe they have already exhausted most of the cheapest oil reserves and have moved to costlier production. I would have expected them to stick to a 60-70 range if that was not the case considering the kind of external market share competition the ravenous drilling in the US is bringing.
If oil demand does peak in 2023, then the prices might very well drop to a point where the US product will definitely need a lower breakeven to be anywhere near profitable and thus sustainable (without massive subsidies or the torching of investor capital). I have my doubts that this will be possible in 5 years time when sweet spot reserves are even lower.
So maybe they see the US output as only temporary due to the apparent best resources being depleted quickly without any profit. In that case 70-80 would just result in a quicker burnout than 60-70.
If both the US and OPEC need oil prices to be at 70-80 while at the same time oil demand peaks and starts lowering, they will probably have to lower production to keep the range. We should witness a shift to a downward trend in worldwide production numbers at that point.