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Analysis: Saudi Arabia signals aggressive cuts to show commitment to OPEC output deal

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Analysis: Saudi Arabia signals aggressive cuts to show commitment to OPEC output deal


Falih says Saudi Arabia may cut below 10 million b/d

Comments suggest kingdom will lead by example

Saudi policy informed by previous experiences with cuts

London —
Saudi Arabia, the world's largest oil exporter, is making it clear to the global market: the kingdom wants the output deal it negotiated with major producing countries to stick, even if it has to cut production more than it already committed to.

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With the market watching on its day off Saturday as OPEC hosted a meeting in Vienna with a dozen non-OPEC producers to seal the output cut agreement, Saudi energy minister Khalid al-Falih declared that his country was prepared to slash production below 10 million b/d, after having previously agreed to cut down to 10.058 million b/d.

That means that Saudi Arabia could go beyond the expected season declines in production that many experts had expected the bulk of its reduction under the deal OPEC announced November 30 to come from.

"I can tell you with extreme certainty, absolute certainty that effective January 1, we're going to cut and cut substantially to below the level we have committed to on November 30," Falih said at a press conference in Vienna.

And the declaration came fresh on the heels of state-owned Saudi Aramco reportedly informing its customers on Friday that its January export nominations would be lower to conform with the agreed cuts.

With these gestures, Saudi Arabia may be signaling to its partners in the deal to do their part and not cheat on their quotas. It also potentially signals, however, that Saudi Arabia may cover for any cheating countries.

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"The Saudi comments are significant and in my view are a signal they might truly go sub-10 million b/d," said Michael Cohen, head of energy commodities analysis for Barclays.

Under the deal finalized in Vienna on Saturday, 11 non-OPEC countries agreed to cut a combined 558,000 b/d from the market, on top of the approximately 1.2 million b/d that OPEC members committed to cutting at their November 30 meeting.

Saudi Arabia has been pumping above the psychologically symbolic benchmark of 10 million b/d since early 2015, as the kingdom launched a market share battle in the wake of OPEC's momentous November 2014 decision not to cut output in the face of looming global oversupply brought on in large part by US shale.

For the greater part of a year, as many of its fellow OPEC members clamored for an end to the market share strategy, Saudi Arabia insisted that any output reductions would have to be shared equitably -- a stance that failed to get major buy-in until recent months.

Geopolitical rival Iran, one of the last holdouts, finally agreed to hold its output at 3.797 million b/d, a 90,000 b/d increase from current levels -- a concession from Saudi Arabia, but also a win, considering that Iran had insisted on regaining its pre-sanctions production level of some 4 million b/d before accepting any deal.

With the negotiations completed to everybody's satisfaction, Saudi Arabia is keen to see the pact succeed to gain some much-welcome fiscal relief and also bolster its efforts to reform its economy, a task made easier politically and financially when oil prices are not lingering in a $40/b malaise.

"We all benefit together. As the tide rises, all boats will rise," Falih told reporters Saturday as he left the OPEC secretariat. "It signifies there are elements of trust that have built up. We have to reinforce it."


Of course, for now, talk is cheap.

The deal is to be monitored by a five-country committee composed of Algeria, Kuwait, Venezuela, Oman and Russia.

But the six-month output agreement does not come into force until January, meaning that the first independent estimates of OPEC production that the producer group is relying on to verify progress towards compliance will not be available until early February.

The lack of enforcement mechanisms, along with the fact that much of the so-called cuts in the deal consist of natural declines that analysts have already factored into their forecasts for 2017, has prompted skepticism among many market watchers.

"Certainly, the Saudis and other Gulf commitments to cut about 750,000 b/d are real," said Joe McMonigle, an analyst with Hedgeye. "But more than half of the 1.8 million b/d cut is suspect, and I expect we will start to see signs of wide-spread non-compliance early next year. The Saudi comments that they may go below their ceiling is designed to support the shaky non-OPEC part and other real concerns."

The skeptics also include none other than Falih's long-serving predecessor, Ali al-Naimi.

Naimi, now retired, recently said in Washington that a deal between OPEC and key non-OPEC producers to cut output would be good for the market, but "the unfortunate part is we tend to cheat."

And Saudi Arabia has been burned by making aggressive cuts before.

Naimi, in his recently released memoirs, recounted a fateful decision by former Saudi oil minister Ahmed Zaki Yamani in the mid-1980s to cut the kingdom's production to prop up prices, which had slumped in the face of growing supply.

Instead, Saudi Arabia saw those new supply sources from Alaska's North Slope, the North Sea and Mexico take the kingdom's market share, and when it boost production to reclaim what it had lost, prices collapsed further.

That experience heavily influenced Naimi's decision in November 2014 to eschew cuts, which Falih now appears to be reversing, now that almost all major state producers have agreed to cooperate.

Circumstances in the oil market are different now, and the cut Saudi Arabia has committed to is much less than the drastic reductions Yamani undertook, even factoring in Falih's comments that Saudi production could drop to below 10 million b/d.

Rather, the output deal appears aimed at stabilizing oil prices in a $50-$60/b range -- high enough and stable enough to provide producing countries a lift, while not going to high as to encourage a flood of US shale oil back onto the market.


"Our objective as OPEC [and] certainly my objective representing Saudi Arabia is to provide stable energy supply to the global economy and give long-term stability of supplies and reasonable predictability of process," Falih said in Vienna.

It is a delicate gambit that Saudi Arabia, the rest of OPEC and the 11 non-OPEC producers in the deal have embarked on. The cuts could backfire if US shale and other production not bound by the deal prove to be much more resilient to bolstered prices.

Indeed, the US rig count jumped up 21 last week in the biggest single-week rise since July 2015 likely due to the OPEC pact announced November 30.

But the kingdom has signaled it is all in, betting that the market is already on its way to rebalancing, and when it does, Saudi spare capacity, which will be greater thanks to the cuts, will be available to meet any future demand needs.

"The Saudis wanted to send a signal that it's going to be absolutely crystal clear that [they will] cut," said Yasser Elguindi, an analyst with Medley Global Advisers. "It reinforces that these guys don't want prices below $50/b. There's no other conclusion than things have changed in the kingdom."

--Herman Wang,
--Paul Hickin,
--Rosemary Griffin,