What Are the Saudis Up to With Their Oil Production Cuts?

Since last November 2022, Brent oil has been in a tight range of $70/bbl. to $88/bbl. This has been frustrating OPEC, mostly Saudi Arabia, as the price of oil has not been able to break higher.

Price stability is often used as justification for extending their “lollipop” cuts, but then again, a ~ $10/bbl. range for a year seems rather stable especially when oil volatility has been quite low as well. The true intent of cutting production by the extra 1mbpd is really to tighten the markets into the end of the year when demand typically does tend to pick up into Q4 with the northern hemisphere winter.

After extending their extra cut through the end of September, they now announced to extent this cut through the rest of the year. Brent oil rallied only $1.5/bbl. on Tuesday, to give it all back as we end the week. Removing about 90 million barrels for the next three months, and price is unable to rally, says it all. It is not just about supply.

Reading through various analysts’ comments about this extended, punchy, Saudi move, leads most to believe that the market could see a short fall of about 3mbpd into Q4. All through last year, we have stated that relying solely on estimating the supply side is a fools game, as demand is the more important driver in today’s market.

Most banks expect a soft landing, no landing, economy, leading them to see a demand rebound across the board leading to tight oil markets. No doubt that if this were to be a normal year, that would be true. Judging by global PMI indicators and ISM and various metrics, it seems the global economy is about to enter a harsh recession. Europe is already seeing contraction, China is stagnating and unable to do much to boost the domestic consumer.

The US seems to be holding up, but the government stimulus that have helped the US consumer are now coming to an end. Fiscal relief is coming to an end and with inflation not budging below 4% CPI, the Fed really has its hand tied in terms of boosting the economy whilst battling inflation.

Saudi Arabia needs oil prices at $90/bbl. Brent or higher given their fiscal spend and growth ambitions. It is dead serious about seeing higher oil, and that has been the case since last year. That tends to work when one side is the marginal swing producer, as they can tweak production to take prices where they like. But that assumes a constant demand/supply profile. Demand is not a constant and it is seasonal.

The Saudis may be trying to be smart by manipulating prices higher, but at the of the day it is a commodity that will see demand impacted as the economy slows. The bigger question is how much oil production and for how long are Saudis willing to lose market share as the high oil price is incentivizing US shale and other non-open producers to keep pumping as much as possible. At some point the math will not add up.

All these cuts have distorted the distillate fuel oil market given Saudi Arabia oil is heavy, which tends to distort the light heavy spreads. Chinese demand has been strong but it has been importing oil to refine it and export more products, betting the system. As OPEC or Saudi awaits Chinese demand, it may not arrive, especially given how high Brent oil prices are. China has already bought all the oil it needs and stored it.

We all know that when prices move aggressively higher, OPEC is not quick to release enough production to provide stability on the upside nor to stop speculators when they take excessive bets on the long side, but want them to “ouch” when they are short. This short termism may come back to bite them, or perhaps this could be another opportunity to offload some of the crown jewel, Aramco. Time shall tell. After all, if the price of the product and the company is set by the same entity. Does the valuation really matter?

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