Earlier this week, media reported that oil production from the members of OPEC had fallen to the lowest since 2021—or 2020, depending on the source—thanks to voluntary production cuts from Saudi Arabia and involuntary declines in Nigeria, Angola, and Libya.
The news naturally pushed oil prices higher. Yet they have already begun to climb as traders have finally started paying attention to the supply warnings and demand projections that banks and other analysts have been issuing for weeks.
The jump in prices should have made Riyadh happy, and it probably did. The question now is how much higher the Saudis would let prices go before starting to relax their cuts.
The Saudi Arabian economy grew by a modest 1.1% in the second quarter of the year, which was down from 3.8% in the first quarter. Media and analysts attributed the slowdown to lower oil prices, even though the Kingdom’s non-oil sector booked a pretty healthy 5.5% growth rate.
Yet the weight that the oil trade has in the overall economy remains overwhelming despite Riyadh’s efforts to diversify. And this means that it needs even higher oil prices—to continue with the diversification efforts.
Bloomberg’s Grant Smith suggested this week that the Saudis may decide to relax the cut from September as Brent moves to $85 and above. The reasoning was that refiners would welcome the additional barrels, and the Saudis would be happy to boost their market share after losing some of it because of the voluntary cuts.
On the other hand, Smith wrote, longtime OPEC observers were not convinced this would be enough for the Saudis to relax the cuts. Uncertainty about demand was one reason cited, and the risk of disrupting the discipline of OPEC as a whole was another.
Ultimately, however, the Saudis can keep the cap on output for exactly as long as they need to in order to get prices where they want them to be. It is yet another demonstration that not only is OPEC very much alive and relevant in today’s world, but its de facto leader still has plenty of sway over the group.
“The kingdom will want to see a protracted rise toward $90 a barrel and possibly improvement in Chinese economic data to start considering putting the 1 million barrels per day back into the market,” PVM Oil Associates analyst Tamas Varga told Bloomberg earlier this week.
Meanwhile, Goldman Sachs updated its outlook on oil demand in a way that should please Riyadh. The bank said oil demand had hit a record in July, reaching 102.8 million barrels daily, and that this would lead to a deficit of 1.8 million bpd in the second quarter of the year.
In such a context, there is really no rush for Saudi Arabia to return those barrels to the market. Especially if they are not exactly a whole million. This was suggested by an unnamed EU source who spoke to Oilprice.com’s Simon Watkins, saying that the production data for Saudi Arabia showed no cuts were being made from fields that the Saudis operate in a neutral zone that the Kingdom shares with Kuwait.
In other words, Saudi Arabia may be cutting some barrels but pumping plenty in the neutral zone and selling those “under the radar,” as Watkins reported. This would allow it to benefit from higher prices, boost its market share, and simultaneously continue to exert upward pressure on prices with the official cuts.
Meanwhile, the American Petroleum Institute did the Saudis a huge favor by reporting an estimated 15.4-million-barrel inventory drop for last week. The massive figure seriously exceeded analyst expectations, which were for a much more moderate inventory decline of less than a million barrels.
Traders are rushing to cover their short positions in oil, too, and this is boosting prices further. The benchmarks jumped to a three-month high this week as funds bought crude and fuels and changed their bets from bearish to bullish.
All this works in Saudi Arabia’s favor, and it also suggests prices could reach the level Riyadh would like to see sooner rather than later. And that’s when things would get interesting: announcing an end to the cuts would be unwise as it would immediately cause a plunge in prices. A gradual relaxation is a more likely option, as suggested by analysts surveyed by Bloomberg this week.
According to them, the Saudis could decide to relax the cuts by 250,000 to 500,000 barrels daily from next month. Then again, they might decide to stick with them for another month and see how high prices would go.
Some, like Energy Aspects’ Amrita Sen, have forecast that Brent could hit $100 before the year’s end thanks not just to cuts but the shrinking inventories as well. That was a month ago. Now, Reuters is also reporting that global oil inventories are in decline. It would take a negative GDP growth reading for the U.S. or China to stop this rally.