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ANALYSIS: Saudi Arabia comes to the aid of OPEC+ but seeks goodwill in return

Highlights

Prince Abdulaziz shifts from quota enforcer to benefactor

Increasing split between Russian, Saudi oil policy

Wobbly oil demand, budget pressures weigh on kingdom

London — Ever since Saudi energy minister Prince Abdulaziz bin Salman took his post in August 2019, he has cracked the whip on OPEC+ compliance, pressuring, scolding and cajoling quota violators to step up their production discipline.

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He has vowed that Saudi Arabia, OPEC's largest member and the world's biggest crude exporter, would no longer tolerate free riders and bear an uneven burden of balancing the oil market on its own.

So what a turnabout on Jan. 5, when he announced a surprise unilateral 1 million b/d production cut for the kingdom – about 10% of its current output – even as four-year oil ally Russia, the least compliant OPEC+ member, lobbied for and won an increase in its quota.

Prince Abdulaziz revealed the steep cut to reporters after the OPEC+ alliance wrapped up two days of talks, catching the oil market off guard, saying it was a gift of goodwill to other members and the entire beleaguered industry. The extra cut will be implemented in February and March.

Oil prices responded strongly to the move, hitting 10-month highs, and the additional revenue will hopefully incentivize countries to stick to their quotas and even implement the so-called "compensation cuts" they owe under the deal for previous overproduction, Prince Abdulaziz said.

"This gesture...will help and support friends and colleagues to continue this unprecedented commitment of achieving 100% compliance, and help those countries that are still training with their compensation to compensate over January, February, March and April," he said.

OPEC+ bonhomie aside, analysts are left to speculate as to the kingdom's intentions, whether it is aimed at a short-term jolt for prices or serious concerns about the future shape of global oil demand, with the coronavirus pandemic surging again.

Internally, Saudi Arabia has slashed its budget as its oil revenues have crashed, while its economic diversification efforts have yet to take root.

Meanwhile, oil consumption remains hobbled by the pandemic. The US, the world's largest user of oil, imported zero Saudi crude for the week ending Jan. 1, the first time this has happened since the US Energy Information Administration began tracking the data in 2010 -- a potentially troubling sign for the kingdom, typically one of its key suppliers.

Keeping members in line

Prince Abdulaziz said the move was "preemptive," just in case infection rates worsen and threaten to bring down the market in the coming months, and that he was not worried about the current state of demand.

But it may also backfire and be seen as a reward for quota cheating.

According to OPEC+ analysts' own accounting, five OPEC members and six non-OPEC countries have exceeded their caps by a combined 2.461 million b/d from May through November. Most flagrant among them is Russia, which has overproduced by 604,000 b/d.

And now Russia will be allowed a 65,000 b/d rise in its quota for February and another 65,000 b/d for March, under the agreement.

Kazakhstan, the only other OPEC+ member who was granted a production increase, of 10,000 b/d each month, has pumped 213,000 b/d over its quota.

The rest of the OPEC+ alliance, many of whom have also sought looser quotas but have been shot down, will be required to maintain their January levels.

For all of his tough rhetoric on quota cheaters, Prince Abdulaziz has largely given Russia a pass on its violations. It reflects perhaps the reality that the OPEC+ alliance carries much less weight if Russia, one of the world's top three crude producers, were to be driven away.

"Riyadh's decision to effectively forego market share represents a capitulation to Russia's demands to boost output," said Stephen Brennock, an analyst with PVM Associates.

Diverging priorities

Russia, for its part, could do nothing to stand in the way of Saudi Arabia's willpower.

At a Dec. 19 meeting in Riyadh with Russian Deputy Prime Minister Alexander Novak, Prince Abdulaziz revealed his plan for the extra cut, which was otherwise kept secret from the other OPEC+ members.

Novak pleaded with the prince to demur, arguing that the resulting rise in prices would only incentivize US shale rivals back into the market, but this was a "political and sovereign decision, Abdulaziz told reporters.

The cut will bolster prices through the seasonally low-demand first quarter, and the backwardation in the Brent forward crude structure could induce draws of oil from storage to shrink the glut in inventories, as long as refinery runs hold up.

Beyond potential OPEC+ quota cheating, additional crude may be coming onto the market from Libya as it resuscitates its oil industry after years of war and Iran, which is already anticipating an easing of sanctions when US President-elect Joseph Biden takes office on Jan. 20.

The OPEC+ alliance will meet again on March 4 to determine April quotas. The coming weeks will determine if Saudi Arabia's new approach will bring about the benefits – and OPEC+ solidarity – it hopes for.