Saudi Arabia, the world's main oil producer, recently overtaken by the U.S. as one of the largest producers of oil, still holds the key to the oil market. Hence its strategy and vision is important to understand the supply dynamics as they control about 10 mbpd, Russia more or less the same, and U.S. around 11 mbpd. However, looking back over the past six years, no oil producing or commodity producing country has taken that many U-turns and made surprise moves as Saudi Arabia has. It is no wonder that most portfolio managers shy away from trading the oil market as they just cannot seem to forecast the geopolitics of it all.
In 2014, Saudi Arabia was tired of conceding market share and decided to flood the market with oil to fend off the growth of U.S. shale oil. Oil prices collapsed below $60/bbl. Brent, a bit too far and after some changes, Saudi Arabia changed course in 2016 and along with Russia changed decided to cut about 2.5 mbpd of oil output to keep prices stable. As much their intention was to support prices, 2018 was met with Trump led trade wars and economic slowdown which leaned further on oil. Then came 2020 with coronavirus that just sealed the fate for oil altogether. During this time, oil prices already fell down to $50/bbl. as the world was going into lockdown. When Russia did not give into further production cuts, what did they do? They decided to teach them a lesson and flood the market with an extra 2.6 mbpd of oil when world was staying at home! Their desire was to frighten Russia to make a deal, which then backfired as oil prices went negative and everyone got hurt!
The logic during Q1 2020 was that if they produced more of something at a lower dollar value, perhaps their net national revenues would be the same. The math didn't quite work out as what seemed prudent at first was not so after oil fell to -$20/bbl.! So much for market share. After a year of Trump brokering a deal between Saudi Arabia, Russia, and themselves to keep production constant giving the oil market time to recover, it seems they have thrown another spanner in the works. This week OPEC+ was due to meet to discuss raising oil production slowly month by month as prices recovered above $53/bbl. Brent. Even though there has been tremendous stimulus globally and demand is surely but slowly recovering, there is still an excess of 7.7 mbpd of oil. After raising production by 500k bpd in January, the consensus was to perhaps raise it by another 500k bpd. The market could probably have soaked that excess easily as Chinese and Indian buying offset the slowdown in the U.S. and EU. But what did they decide to do? A surprise CUT of 1 mbpd of Oil in February and April! The rationale behind this move was on the back of further slowing demand post further lockdowns on the new Covid strain, but it appears the decision was more politically motivated. The oil market squeezed up 5% in one day with oil majors and U.S. shale stocks up between 8%-15%.
Perhaps the logic this time seems to produce less of something at a much higher price to equal the same revenues? We know Saudi Arabia needs at least $85-$90/bbl. Brent oil prices to breakeven fiscally. Their plans to expand are dependent upon more oil revenues before diversifying their economy away from oil. This may be a risky move as the world is now dealing with inflation expectations as every commodity is trading multiples higher. Higher oil prices can exacerbate that trend. In addition, there is too much uncertainty as to how the new Covid strain will develop or how fast the vaccine might roll out, as demand is still the big unknown.
At the end of the day, oil is not like copper that takes years to invest and mine, but it is readily available given excess investments of the past. It seems Saudi Arabia is just buying time to support oil, but if demand does not go back to pre-Covid levels by April, these extra 8.5 mbpd of oil are just waiting to come back to market. Their is no shortage.
