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Insight: Saudi Arabia juggles geopolitics and oil prices

Saudi Arabia is putting its crude production capabilities – and its ability to balance the oil market – to the test.

The kingdom finds its oil production policy at a crossroads, with the need to appease allies countered by its desire for higher prices to balance its books.

Urged by US President Donald Trump to cool what was then a heating market, Saudi Arabia pledged June 23 along with the rest of OPEC, Russia and nine other non-OPEC partners to boost crude output by a collective 1 million b/d, in anticipation of supply shortages caused by US sanctions on Iran and Venezuela’s spiraling economic crisis.

Even before the ink had dried on the vaguely worded OPEC deal — which spelled out no specific quotas — Saudi officials were letting it be known to analysts that the kingdom was ready to pump as much as 11 million b/d, which would be a record high by far. But after an initial surge in output in June, Saudi Arabia said it was forced to cut production by some 200,000 b/d in July to 10.29 million b/d, due to lackluster demand, in what analysts said was likely an attempt to prevent prices from falling too far too quickly. Saudi Arabia’s August output then rose modestly to 10.42 million b/d, an OPEC source told S&P Global Platts.

With the demand outlook hazy and supply risks on the horizon, the world’s largest crude exporter faces a delicate balancing act. Pump too much too quickly, and OPEC – already politically fractured over quota compliance – could flood the market as slowing economic growth in Asia and intensifying trade battles temper global consumption.

But keep too firm a grip on the taps, and the market could overtighten from the impact of US sanctions on Iran and Venezuela’s worsening crisis.

“In the short term, Saudi Arabia is trying to maintain the stability of the oil market to support consumers’ demand, and in the long term trying to keep prices following the uptrend to help producers maintain investment,” said Mazen al-Sudairi, head of research for Riyadh-based Al-Rajhi Capital. ”So the industry needs an increasing oil price and increasing production, and not just Saudi Arabia.”

Barrels needed?

Not including newest member Congo, which joined the organization in June, OPEC crude output in August was 32.57 million b/d – 670,000 b/d above its May level – according to the latest S&P Global Platts OPEC production survey, as Iraq surged to a record high and Libya recovered from militia attacks.

In that span, Russia has boosted its production by about 240,000 b/d. That puts OPEC and Russia nearly all the way to the 1 million b/d increase above May levels that they had agreed at their June 23 meeting.

The coalition may have to go even further than what its deal calls for, with OPEC’s analysis arm forecasting that global demand for OPEC crude in the third and fourth quarters of this year will hit 33.32 million b/d.

From a technical standpoint, Saudi Arabia holds the vast majority of OPEC’s remaining spare capacity and says it can easily pump as needed to meet expected demand in the months ahead. Politically, however, the kingdom may find it a tougher task, with Iran and Venezuela opposed to any country producing above its individual quota.

Iran, which has threatened to block regional exports if its market share is threatened, has accused Saudi Arabia and its Gulf allies of violating OPEC statutes in pumping above their allocations. Saudi Arabia has already boosted its output to far above its quota of 10.06 million b/d, though it has said its interpretation of the deal is that individual caps are out, while a collective ceiling is in, given that several members – Iran and Venezuela among them – are incapable of pumping more.

“Collective increases in OPEC crude production will need to carefully balance Iranian and Venezuelan sensitivities with promises pertaining to the group’s official goals of seeking a balanced market and being reliable suppliers,” said Harry Tchilinguirian, BNP Paribas’ global head of commodity markets strategy.

A six-country Joint Ministerial Monitoring Committee, chaired by Saudi energy minister Khalid al-Falih, meets September 23 in Algiers assess market conditions and discuss next steps. The JMMC also includes ministers from Russia, Kuwait, Venezuela, Algeria and Oman.

Iranian oil minister Bijan Zanganeh, who does not sit on the committee, also plans to attend the meeting to press his case.

Falih was not shy about his country’s divided loyalties at OPEC’s June meeting in Vienna, telling reporters that as much as he respects the desires of Iran, Venezuela and other distressed members, “my bigger guiding principle is to be respectful of what the market needs.”

Flexible intentions

A collision course between longstanding geopolitical rivals Saudi Arabia and Iran seems almost inevitable.

Saudi Arabia’s state-owned oil company Aramco in August cut its official selling prices for its flagship Arab Light crude loading in September to all markets, except the US, signaling that it is gearing up for a more competitive market, particularly in Asia. Iran promptly followed suit, with National Iranian Oil Company aggressively slashing its OSPs across all grades loading in September.

“The Saudis are positioning themselves to fill the void left by missing Iranian barrels,” said Stephen Brennock, an analyst with brokerage PVM Associates.

Iran crude exports

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Iranian oil exports in August slumped to their lowest level in seven months, data from S&P Global Platts shipping tracker software cFlow showed, as buyers have begun to shy away from trade with Tehran.

Iran’s crude and condensate exports stood at 1.92 million b/d in August, compared to 2.32 million b/d in July. S&P Global Platts Analytics expects the US sanctions on Iran to eventually shut in 1.4 million b/d of Iranian exports by November.

The US has announced plans to sell 11 million barrels from its Strategic Petroleum Reserve between October 1 and November 30, in part to cushion the market impact from sanctions on Iran. At the same time, some analysts anticipate Venezuelan production falling 300,000 b/d or more by year end.

Meanwhile, trade frictions between the US and China could dampen crude consumption, with OPEC forecasting that tariffs on both sides could reduce 2019 oil demand by up to 350,000 b/d in a worst-case scenario. Already, Chinese demand growth has slowed this year, with crude imports stagnating as independent refineries cut back on their purchases of foreign oil.

“The risks to stable supply that will grow later this year could cause higher prices and thus impact demand growth,” the International Energy Agency warned in its August monthly oil market report.

The supply challenges posed by Iran and Venezuela – not to mention volatile Libya – plus infrastructure constraints in the US’ Permian Basin that could cap output growth there, will put an outsized focus on Saudi Arabia’s willingness and ability to play swing producer.

The pressure from Trump to keep a lid on oil prices may ease after the November 6 midterm elections in the US, but that is just a day after the sanctions on Iran go into effect, when Saudi barrels may be needed to keep the market sufficiently supplied.

Domestic concerns are also a consideration, with Saudi Arabia trying to implement its ambitious economic reforms under its Vision 2030 program.

The long-mooted share flotation of state oil company Saudi Aramco that was intended to fund much of the reforms appears indefinitely delayed, with kingdom officials saying they are waiting for more favorable market conditions.

The International Monetary Fund estimates that Saudi Arabia requires an oil price of about $80/b to balance its budget.

“In a more uncertain environment, Saudi Arabia is in need of flexibility in its output policy, but this has the effect of diluting its signals at times, to the dismay of many in the market,” said Bassam Fattouh and Andreas Economou of the Oxford Institute for Energy Studies in a recent note.