Oil prices were up $1 a barrel after Saudi Arabia pledged to cut production by another 1 million barrels per day beginning in July at the recent OPEC Plus summit to raise oil prices. The arrangement was a compromise, which Prince Abdulaziz bin Salman, the Saudi oil minister, called “a Saudi lollipop “ that is meant to increase prices for oil traders. So far, Saudi Arabia’s cut is only for July, but it could be easily extended, depending on the market reaction. The cut is to raise oil prices as Brent oil, the global benchmark, is around $77 a barrel, after trading around $120 a year ago. Analysts estimate that Brent oil needs to stay at $81 a barrel for Saudi Arabia to keep its budget balanced and to finance its infrastructure program backed by the country’s crown prince, which includes a planned $500 billion futuristic desert city project called Neom. The Saudis need sustained high oil revenue to fund ambitious development projects aimed at diversifying the country’s economy.
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Fast Facts:
- Oil prices were up $1 a barrel after Saudi Arabia pledged to cut production by another 1 million barrels per day beginning in July at the recent OPEC Plus summit to raise oil prices.
- Saudi Arabia is making the cut alone as the other OPEC+ producers agreed to extend earlier production cuts through next year.
- The short-term impact of the production cut will be higher prices, but the long-term impact is not clear and depends on whether Saudi Arabia will extend its production cut beyond July.
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Saudi Arabia is making the cut alone as the other OPEC+ producers agreed to extend earlier production cuts through next year. Saudi Arabia’s oil output would drop to 9 million barrels per day in July from about 10 million barrels per day in May, which is the biggest cut by Saudi Arabia in years. Tension, however, arose among the members at the meeting. The United Arab Emirates saw its production quota grow by 200,000 barrels per day to 3.22 million barrels per day to reflect its larger production capacity, while other countries had their targets reduced. Russia, along with three African countries—Nigeria, Angola and Congo–will bear the brunt of the cuts but will have little real impact as the lower targets for Russia, Nigeria and Angola bring them in line with their actual production levels. African producers were unhappy with the U.A.E.’s efforts to increase its production quotas.
The short-term impact of the production cut will be higher prices, but the long-term impact is not clear and depends on whether Saudi Arabia will extend its production cut beyond July. Goldman Sachs analysts estimate that the cut could raise the price of December 2023 Brent oil by $1 to $6 per barrel, but is unlikely to hurt U.S. consumers much since gas prices at the pump are down almost 25 percent over the past year. Of course, that is assuming U.S. gas markets could tolerate the higher prices of last year. Prices at the pump average $3.55, down $1.02 from a year ago, according to AAA. But, as oil inventories are drawn down in the third and 4th quarters, analysts are saying that oil prices could approach $100 a barrel. The Saudi cut provides “a price floor” because the Saudis can play with the voluntary cut as much as they like until they get the oil price they want.
Russia, a member of OPEC+, is believed to be producing huge amounts of oil, despite Western sanctions and a lower quota, and selling it at a discount to India, China and Turkey. The Group of Seven major democracies imposed a $60-per-barrel price cap on Russian oil. Russia, however, has found ways to evade the price cap through “dark fleet” tankers, which tamper with location data or transfer oil from ship to ship to disguise its origin. High Russian production levels, and its increased share of Asian markets including India, often at the expense of Middle East oil producers, have become a sensitive issue in OPEC+, affecting the tension at the meeting. Russia is the world’s third-biggest oil producer and is targeting production of around 9.5 million barrels per day until the end of the year and 9.3 million barrels per day next year.
That the Saudis felt another cut was necessary underlines the uncertain outlook for demand for oil. There are concerns about economic weakness in the United States and Europe and slowing economic growth in China is keeping oil demand low and a lid on oil prices. China’s rebound from its COVID-19 restrictions has been less robust than many had expected. Further, China is notorious for non-transparency in the reporting of its economic numbers, increasing uncertainty.
Past OPEC+ Production Cuts
Saudi Arabia, the dominant producer of OPEC oil, was one of several members that agreed on a production cut of 1.6 million barrels per day in April, of which Saudi Arabia’s share was 500,000 barrels per day. The Biden administration called OPEC+’s action in April inadvisable. The previous October, OPEC+ had announced that it would cut production by 2 million barrels per day, which angered President Biden by threatening higher gasoline prices a month before the midterm elections. Biden responded by placing more oil from the Strategic Petroleum Reserve (SPR) on the market, collapsing the emergency reserve to an almost 40 year low. Despite refill announcements by the Biden administration and low oil prices, which were a condition for refilling the reserve, little has been done to refill it.
Since last October, OPEC+ has announced production cuts of 4.6 million barrels a day. But, because some countries cannot produce their quotas, the actual reduction is 3.66 million barrels per day, or 3.6 percent of global demand. OPEC+ produces about 40 percent of the world’s oil.
Conclusion
OPEC Plus, in a statement, said that it was acting “to achieve and sustain a stable oil market,” and that it was continuing its recent approach of being “proactive, and pre-emptive.” Despite that statement, OPEC+ is cutting oil production to increase prices, which Saudi Arabia needs sustained at around $81 a barrel to fund its infrastructure program. Weak demand and Russia’s continuing production to fund its war effort have kept prices low, despite Western sanctions on Russian oil. Saudi Arabia’s production cut of 1 million barrels per day is voluntary for the month of July, but can be extended, depending on the market. Oil prices increased by $1 per barrel due to the announcement, but analysts do not believe that gas prices will be affected much since they are down a $1.00 a gallon since last year due to President Biden’s selling off SPR oil by 260 million barrels as the mid-term elections loomed. He has yet to refill the emergency oil reserve, despite promises to do so.
