Saudi oil policy adrift despite Aramco’s eye-watering earnings

Saudi Arabia has no easy answer to falling oil prices. The kingdom could provoke an international backlash by slashing exports, or open a new war with US shale producers by flooding the market with cheap crude. The former risks the ire of President Donald Trump, but the latter would shatter the fragile economies of its OPEC partners and threaten the IPO of Aramco.

The value of Brent crude has slumped 20% since April and traded for most of last week briefly below $57/b after a slew of bad data tethered the market’s few remaining oil bulls. OPEC’s members led by Saudi Arabia require oil trading closer to $80/b to sustain their high-spending autocratic economies. Higher prices are also a prerequisite for Saudi Aramco’s delayed IPO, despite the state-owned producer reporting almost $47 billion of net income in the first half.

OPEC and Saudi Arabia’s main rivals in America’s prolific Permian and Bakken shale basins appear to have no such worries. For example, Shell says its existing wells in Texas and New Mexico can turn a profit at $35 per barrel. This explains why the US is now the world’s largest producer, pumping 12.3 million b/d of crude last week, according to official data.

Middle East producers like Saudi Arabia could pump more oil, much cheaper, but they cannot afford to do so because of the region’s dependence on fossil fuel exports as the main source of foreign currency earnings. Former Saudi oil minister Ali Al-Naimi tried this strategy in 2014 when he launched an ultimately doomed price war against Wall Street funded US shale. It’s a policy the kingdom is unlikely to repeat.

Demand forecasts cut

The International Energy Agency (IEA) piled on more pressure last week, when it lowered forecasts for oil demand growth through to 2020. The Paris-based watchdog reduced its outlook for global consumption growth this year by 100,000 b/d to 1.1 million b/d and trimmed next year’s forecast to 1.3 million b/d, citing worries of weakening economy and uncertainty over America’s trade war with China.

"The outlook is fragile with a greater likelihood of a downward revision than an upward one," warned the IEA. Discounting the IEA’s hit-and-miss reputation as a forecaster, the revision comes as a body blow to OPEC and its oil-producing allies led by Russia. Two years of production restrictions by the cartel have failed to restore prices to economically sustainable levels.

Riyadh has hit the panic button. The kingdom – still OPEC’s largest producer of crude – has already reduced its exports to below 7 million b/d this year and may decide to cut shipments further at least until the outlook for global economic growth – the main driver for crude demand – becomes clearer.

The slide in prices is even more shocking given the threat to oil shipping passing through the Strait of Hormuz from Iran and the loss of exports from the Islamic Republic caused by US sanctions. Iran’s exports may have fallen to below 500,000 b/d and the country has resorted to storing its unsellable crude aboard its fleet of super tankers. Output from Venezuela – owner of the world’s largest oil reserves – has also been choked off by embargoes.

None of which has boosted prices.

Officials from Saudi and other members of the cartel will meet with their allies and Russian counterparts at a crunch OPEC committee meeting in Abu Dhabi next month. However, Moscow’s willingness to match Saudi Arabia’s cuts to exports isn’t necessarily guaranteed, despite their alliance to manage oil markets. After all, the Russian economy can purr along with prices as low as $40/b. The group will also want to avoid adding to the world’s economic problems by inflating the price of crude.

Despite the doom and gloom, some forecasters argue there is no need for OPEC to panic. Demand growth above 1 million b/d means the world is still on track to consume on an average daily basis more than 100 million barrels. Volumes of oil squirrelled away in storage have fallen and new regulations kicking in next year on the specification of marine fuel are expected to see the world’s refineries working full-tilt to meet demand from shippers.

“Fundamentals suggest Brent prices should be much stronger,” said Chris Midgely, global director at S&P Global Platts Analytics. “We still expect Brent to find strength into September, pushing higher into year-end where our fundamentals support prices in the $70s.”

Nevertheless, oil trading at its current levels is a problem Saudi Arabia cannot afford to ignore.

This article was previously published as a column in The Telegraph