I guess we should all take a moment to express our sincere and profound gratitude to Saudi Arabia for finally bringing some “stability” to the global oil market.
Because I really don’t know how we could have survived any more of those wild price swings between $70 and $80 a barrel – my head’s spinning just thinking about it…
Obviously, the Saudi commitment to “stability” is as ridiculous as Congress saying that the real winners of the debt ceiling bill were the American People. Neither House (Saud or Representatives) gives a crap about anything past their own interests.
But I gotta say, the Saudi move to cut its oil output is not going to have the desired effect on oil prices. And in fact, whatever semblance of stability the global economy is now experiencing is likely to unravel when the Saudis realize they’ve screwed up again and get pissed off about it.
The Saudis announced their 1 million barrel a day production cuts after an OPEC+ meeting over the weekend. The group currently known as OPEC+ is made up of the old OPEC countries (OPEC Classic?) – Iran, Iraq, Saudi Arabia, Kuwait, Venezuela, etc – plus 10 more oil-producing countries, most notably Russia and Mexico.
The 24 countries that make up OPEC + cover roughly 55% of global oil production and 90% of the world’s reserves…
Saudi Arabia was the only one out of the 24 that thought cutting oil supply (again) was a good idea. Pretty funny if you think about it. Because while Saudi Arabia was the second largest oil producer before its announced production cut, and will drop to #3 when (and if) it implements the announced cuts, its influence has obviously waned.
And that’s true both politically and economically. Saudi Arabia couldn’t pressure any other country to join it in cutting oil production. And the price of oil itself is acting like it hasn’t noticed – oil for delivery in July is up just 1.2% to $72.60 as I write…
Saudi Arabia vs. Russia
Before the U.S. shale revolution, Saudi Arabia was the bully on the oil block. It could throw its weight around and force prices to do whatever it wanted. That changed in 2013…
By the end of 2013, U.S. oil production had grown to nearly 8 million barrels a day. And so in its infinite wisdom, the Saudis decided to open the oil spigots, crush oil prices and drive the threat of U.S. oil production out of business.
The plan didn’t work.
Sure, by the end of 2015, oil prices had cratered to $30 a barrel. But U.S. oil companies had increased production to over 9 million barrels a day. U.S. oil production did fall back below 9 million barrels a day in the second half of 2016. But by then it was too late – Saudi Arabia had blown a couple billion dollar hole in its budget and had no choice but to cut production to support prices.
Plus, U.S. oil companies did what you’d expect companies in a capitalist system to do when faced with falling prices – they cut production costs nearly in half. We should probably thank the Saudis for making U.S. oil companies lean and mean…
But this time around, it’s not the U.S. that Saudi Arabia is thinking about. It’s Russia. And this is where the Saudi strategy starts to seem ill-conceived.
Saudi Arabia and OPEC+ have already cut production a couple times this year. And if Saudi Arabia follows through on this weekend’s announcement and actually cuts its own production to 9 million barrels a day – which would be a 10-year low – there’s really only one beneficiary: Russia.
Russia has agreed to OPEC+ production cuts this year, saying it cut by 700,000 barrels back in March. But the price action for oil suggests that Russia probably didn’t cut at all. After all, Putin does have a war to pay for, and he’s not really what you’d call trustworthy in the best of times.
All About China (and India)
Ever since Russia invaded Ukraine, the flow of Russian oil to Europe has slowed to a trickle. But Russian oil sales to Asia have doubled. Not only that, sanctions on Russia mean that China and India pay $10 to $15 a barrel less than global benchmark prices for Russian oil.
Not surprisingly, Saudi Arabia has been forced to sell its own crude at a discount (albeit a smaller one) to maintain its market share in Asia. And that’s significant because Asia accounts for around half of Saudi oil revenue.
The EU is now the region paying a premium for the oil it needs to offset Russian supply. But the majority of that supply deficit is coming from the U.S. and Norway.
So the price squeeze that Saudi Arabia is trying to orchestrate is directed at Asia.
And if Saudi’s cuts create any kind of supply issues, I’d expect Russia to do whatever it can to meet them.
Asia is the only market in the world that is seeing any kind of demand growth for oil…
And the significance of Russian oil to Asia – from both a volume and a price perspective – means that Russia, not Saudi Arabia, is now the swing producer that has the most influence on global oil prices. ‘
I’d expect that Saudi Arabia is smart enough to understand that it is competing with Russia for Asian oil revenue. The question is: how long will Saudi Arabia sacrifice market share and lost oil revenue in Asia in order to boost prices?
My guess? I bet Saudi Arabia doesn’t cut its production at all this time. And judging by the lack of any gains for oil prices after the announced Saudi cuts, I think that’s exactly what the market thinks, too.
That’s it for me today, take care and I’ll talk to you Wednesday…
Chief Investment Strategist