Saudi’s whisper of weak oil

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From Deutsche:

The emerging shift in Saudi strategy means that it may be stepping away from its predominant role as the sole provider of swing capacity in the market. This role encompasses both curtailments in times of oversupply as well as increases in response to unplanned supply disruptions. While both activities entail costs either in the form of reduced revenue or idle capacity, the indicated shift should be understood as a rejection of the former rather than the latter, since only Saudi Arabia holds any significant spare capacity. As of last month, Saudi spare capacity is estimated at 2.7 mmb/d against an estimated 0.8 mmb/d for all other OPEC members combined.

According to Reuters, this purported shift in strategy has been communicated by Saudi officials in meetings in New York last week. It appears to reveal that the kingdom is willing to tolerate Brent prices between USD80-USD90/bbl for a period of 1-2 years in order to achieve two aims:

  • to slow increases in US tight oil production and
  • to pressure other OPEC members to contribute to supply discipline.

If true, this would mark a significant divergence from the acceptable range of prices previously stated by oil minister al-Naimi as being “$100, $110, $95.” The possibility of such a change is made more plausible by analysis carried out by Deutsche Bank Emerging Markets Research which showed that Saudi Arabia is equipped with sufficient government assets to weather the budget deficits which would result from Brent at USD83/bbl for a period of 7-8 years, assuming no changes to nominal spending, Figure 12.

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While North American production cannot be entirely suppressed by Saudi Arabia, it appears its goals are to slow it dramatically as Reuters confirms their comment that The Kingdom “will accept oil prices below $90 per barrel, and perhaps down to $80, for as long as a year or two”.

…As DB continues, while Saudi efforts to preserve market share may be viewed as pure conjecture, recent data does suggest efforts are underway to preserve market share.

As a consequence, total OPEC production relative to its 30 mmb/d quota has risen from virtual compliance with the quota from January to May, to one where as of last month the cartel is producing between 700-900 kb/d above its agreed production allocation.

…and we can observe that the differential of Saudi Arabia’s Arab Light blend versus the Oman/Dubai average for Asian deliveries has fallen sharply from a premium of USD1.65/bbl for September loadings to a discount of USD1.05/bbl for November loadings. This suggests that Saudi Aramco is determined to maintain current levels of exports at the expense of sales prices achieved. This represents the sharpest discount since the -USD1.25/bbl level observed in December 2008, during a quarter in which global oil demand contracted by 3.0 mmb/d, in contrast to the current quarter when we still expect oil demand to grow by 0.8 mmb/d.

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Don’t forget that LNG also competes with oil and a little market share loss in some very expensive new projects Downunder would be the icing on the cake…

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.