By: Dan Eberhart – Forbes – Saudi Arabia’s decision Tuesday to cut an additional 1 million barrels a day of production in February and March has two important consequences for oil markets.
First, it means the recent bull run in oil prices has more upside than originally thought, as evidenced by the $2.50 a barrel surge in benchmark Brent to nearly $54 immediately following the news. U.S. oil prices meanwhile hit $50 for the first time since February.
Second, it shows that Saudi Arabia is stuck making deep supply cuts for the foreseeable future and must shoulder more of the burden of balancing the market in order to keep the fragile OPEC-plus alliance together.
There’s no such thing as a free lunch, but this surprise move by the Saudis is about as close as you’re going to get.
With Russia pushing to add another 500,000 barrels a day of OPEC-plus production in February and Saudi Arabia seeking to maintain January’s quotas due to concerns about demand losses from new Covid-19 lockdowns, the two leaders of the group found themselves at odds once again.
Saudi-Russian differences over OPEC-plus policy famously resulted in the disastrous price war in March 2020, and it appears that Riyadh wants no part of another price collapse. Instead, the Saudis will grin and bear it, agreeing to a voluntary 1 million barrels a day cut in February and March on top of its already hefty OPEC-plus reduction target.
Russia and other OPEC-plus members who have been chronic quota cheaters are the clear winners of this decision. It’s becoming increasingly apparent that Saudi Arabia will do everything within its power to keep the expanded cartel together.
A month ago, Saudi Arabia capitulated to demands from the United Arab Emirates and Russia to increase output by 500,000 barrels a day in January. At the time, the kingdom hoped to roll over existing OPEC-plus alliance cuts of around 7.7 million barrels a day through the first three months of 2021.
In the past, Saudi officials would have bullied the other members of the alliance into agreeing to Riyadh’s oil policy positions, using the implicit threat of another price war as the ultimate weapon. But the Saudis’ lost that card when Russia called their bluff last year.
Everyone now understands that Saudi Arabia needs higher prices just as much as everyone else. They watched Saudi Arabia cut its budget for 2021 by 7 percent last month to 990 billion riyals or $264 million. And they see the International Monetary Fund (IMF) projections that Riyadh needs an oil price of $68 a barrel to balance its budget this year.
Saudi Arabia is locked into a policy of supply cuts for the foreseeable future — that gives the other members of the expanded OPEC alliance a strong negotiating hand.
Since last year’s price war ended, it’s been a growing challenge for Saudi Arabia to keep the 23-member OPEC-plus alliance together. Group cohesion is increasingly challenged by smaller producing countries like Mexico and Kazakhstan, as well as traditional Saudi OPEC allies like the UAE and a financially-strapped Iraq.
But Saudi Arabia has always viewed Russia’s inclusion in the alliance as important. The problem is that Moscow has from the start considered participation in the alliance as a short-term fix to get through an unusually tough market. Moscow long ago grew tired of losing market share to U.S. shale, and it doesn’t want this to happen again when the post-pandemic global economy ramps up later this year.
But the Russians won’t have to worry about losing more market share if the Saudis do it for them.
Indeed, under the latest deal, Russia and Kazakhstan can increase combined production by a further 75,000 barrels a day in February, while quotas for other members remain constant with January levels.
That will sting for traditional OPEC members like Iraq, the UAE, Kuwait, Algeria, Nigeria, and Angola.
Many producers whose fiscal budgets depend on oil adhere to the self-imposed production limits, while Russia uses its leverage to up its production unilaterally. How long the rest of the alliance tolerate the special treatment for Moscow is an open question. The issue could flare up more frequently now that the cartel has agreed to meet monthly on the production limits.
It’s hard to envision improved compliance coming out of this latest deal, which means Saudi Arabia must be willing to continue to make up for any shortfalls if demand recovery is slow to recover. The challenge will only intensify if Iran hikes its oil exports, as it says it will, once the Biden administration takes over in Washington later this month.
In oil markets, the bulls are jubilant over the Saudi commitment, which is almost too good to be true for investors. Nobody expected such a bullish outcome – a unilateral cut by the world’s largest exporter – heading into this week’s OPEC-plus meeting.
Calls for oil prices of $65 or higher this year are starting to look more achievable – and could materialize earlier than expected. Indeed, if the market comes out of winter lockdowns in good shape and demand improves significantly in the second half of the year with the mass rollout of vaccines, the $65 level could be conservative.
Markets can thank the Saudis, who appear to have abandoned their “one for all, all-for-one” mantra. Meanwhile, for producers outside of OPEC, especially in the United States, who have struggled to stay afloat under low prices, it’s time to enjoy that free lunch.