Saudi Arabia’s solo play shows mess of oil market contradictions

Saudi Arabia’s decision to deepen its crude oil production cuts, without matching contributions from its allies, underscores how the market is being skewed by a series of contradictory influences.

The world’s biggest oil exporter said it will cut about 1 million barrels per day (bpd) in July, even though the rest of the OPEC+ group decided against any further joint action at its meeting in Vienna on Sunday.

It had been widely expected that OPEC+, which consists of the Organization of the Petroleum Exporting Countries and allies including Russia, would stand pat on output cuts at its weekend talks.

What was a surprise was Saudi Energy Minister Prince Abdulaziz bin Salman’s revelation at a news conference that the kingdom would trim its production from about 10 million bpd in May to about 9 million bpd in July.

“We wanted to ice the cake. We always want to add suspense. We don’t want people to try to predict what we do … This market needs stabilisation,” the minister said.

These comments represent just one of the contradictions in the current oil market.

The desire for a stable oil market is extremely difficult to reconcile with being unpredictable.

The very nature of being unpredictable detracts from stability, with market participants having to adjust to Saudi “surprises”, or even the threat that one of the global oil market’s key players is effectively a rogue actor.

If the aim of OPEC+ is stability, as opposed to defending a price level, then being unpredictable is probably the wrong way of achieving the goal.

The unexpected 1.16 million bpd supply cut OPEC+ agreed to at its April 2 meeting is an example of unpredictability undermining stability.

That move led to global benchmark Brent futures LCOc1 jumping as much as 8.4% higher when trading resumed, although the price only took a few weeks to slip back below the levels prior to the April 2 meeting.

The latest Saudi surprise also sent Brent higher, with the front-month contract gaining as much as 3.4% to $78.73 a barrel in early Asian trade on Monday.

But the risk is that the increase isn’t sustained, largely as a result of another oil market contradiction.

Saudi Arabia’s unilateral move to cut its output in July is a tacit admission that global oil demand isn’t as strong as most analysts and groups such as the International Energy Agency (IEA) have been forecasting.

If demand was indeed as robust as had been predicted, the price of Brent would be able to hold above $75 a barrel with ease, and would likely be biased towards eyeing the $100 level predicted by some analysts.

Instead, Brent keeps slipping towards the $70 level, and it takes extraordinary actions, such as the Saudi solo cut, to keep a positive price bias going.

In effect, the oil market is still operating under the view that demand may be struggling a little currently, but will come roaring back in the second half of the year.

SECOND HALF OPTIMISM

Much of this optimism is built around expectations of sharply higher fuel consumption in China, the world’s biggest oil importer, and to a lesser extent strong demand in India and other developing Asian nations.

The one factor that tends be ignored by the oil market is the role of prices and inventories in shaping Asia’s crude oil import volumes.

China has shown in the past that if refiners believe that prices are rising too fast and too high, they will trim imports and turn to their plentiful stockpiles.

They will also seek out the cheapest global crudes available, and they are already doing so by buying as much Russian, Iranian and Venezuelan oil as possible.

It’s another contradiction for the oil market to resolve as those three exporters are all under some form of Western sanctions.

This means effectively their oil is disconnected from the pricing of the rest of freely available and tradable crude grades.

A further contradiction is the possibility that even as Saudi Arabia cuts output in a move largely viewed as more about boosting prices than achieving stability, the state-controlled exporter Saudi Aramco 2222.SE will actually be cutting its prices.

Aramco releases its official selling prices (OSPs) around the fifth of each month, and a Reuters survey found that Asian refiners are expecting a cut of about $1 a barrel to the benchmark Arab Light grade for July-loading cargoes.

While output cuts are largely a political decision driven by the energy ministry, the OSP levels reflect Aramco’s view of actual physical market conditions.

If the OSPs are trimmed for July, it adds to the view that demand is not living up to the bullish expectations that OPEC, the IEA and others are still espousing.

It may well be the case that the second half of this year sees a huge pick-up in crude oil demand.

But the contradiction that will have to be overcome is China’s economy will need to shake off its so far lethargic recovery, and the rest of the global economy will somehow avoid the recession that most current indicators are pointing towards.
Source: Reuters (Editing by Sonali Paul)