Saudi Arabia, the world’s top oil exporter and the main force behind the OPEC+ production cuts, faces a too familiar dilemma just four months into the new collective agreement to curtail output in order to rebalance the market crushed by the pandemic-driven demand crash. The global oil demand recovery seems to have stalled just as OPEC+ starts to ease the production cuts by 2 million barrels per day (bpd) as of August 1.
OPEC’s leader finds itself in an all-too-familiar position: should it try to regain its own market share again, or should it continue to try forcing full compliance with the cuts, hoping that a tighter market will drive oil prices higher.
Recent signs that oil demand recovery is now slower than many analysts expected could prompt the Saudis to go back to the market-share game, instead of ensuring their unwavering compliance with the OPEC+ cuts, hoping that all others will finally stop cheating and cut as much as they are supposed to, Clyde Russell, a columnist for Reuters, writes.
There are increased uncertainties on the oil market on both the demand and supply side. Demand recovery is surely not V-shaped, and it may have stalled as economies re-open in fits and starts and new localized lockdowns as COVID-19 cases return to grow in many countries. At the same time, global oil supply is also subject to speculation, as OPEC+ and North American producers restore part of the previously curtailed production. Saudi Arabia has promised that the higher production from the eased cuts would go to its domestic market, not to the global oil market.
Saudi Arabia has also promised that the actual OPEC+ cuts in August would be higher than the 7.7-million-bpd as per the agreement because laggards had promised over-compliance to offset previously poor compliance. The biggest laggard in the deal, Iraq, is promising additional cuts of around 400,000 bpd this month as part of its ‘compensation schedule’. Considering that Iraq has never fulfilled a promise as part of the deal since 2017, it’s not certain it will do so this time.
The easing of the OPEC+ cuts as of August comes as signs mount that the oil demand recovery is stumbling, including in OPEC’s key market Asia.
This could prompt Saudi Arabia to cut its official selling prices (OSPs) for the first time in four months. Oil refiners and traders in Asia largely expect Saudi oil giant Aramco to cut the price of its crude oil going to Asia in September as faltering oil demand recovery is depressing refining margins and weakening the Middle East oil benchmarks against which the producers in the Gulf set their prices for Asia.
Saudi Arabia typically releases the pricing for its crude around the fifth of each month, but this month, Aramco delayed the OSP announcement for several days because of a Muslim holiday.
Profit margins for processing crude into gasoline in Asia evaporated through July, crashing from $2.37 per barrel on July 1 to just $0.04 at end-July, according to Reuters estimates.
The world’s third-largest oil importer, India, is seeing refiners cut processing rates because fuel demand has slowed in recent weeks as fuel prices are higher and parts of India are again under local lockdowns, while the monsoon season is also stalling economic activity and transport, officials at refineries told Reuters last week.
Against these bearish developments in terms of demand, Saudi Arabia had no other choice but to cut its prices for Asia for September.
If the weaker-than-expected demand recovery persists beyond September, it could frustrate the OPEC+ efforts to tighten the market and draw down inventories.
Having moved from managing the immediate surplus of the crisis, the OPEC+ cuts are now managing the recovery, Roger Diwan, vice president financial services at IHS Markit, said in a note on Thursday.
“The recent display of restored harmony among OPEC+ heavyweights Saudi Arabia and Russia illustrates that the strategic debate within the group over price levels and market share has time to run,” he said.
“As long as prices hold in the current range, demand concerns will likely help keep the agreement on course. When prices surpass $50/bbl, potentially lifting capital spending in the United States higher, that is when changes to the tenor of the discussion, and the divergence of interest could start to play out,” Diwan noted.
By Tsvetana Paraskova