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The Russians have so far done a pretty good job of convincing the Saudis to do most of the heavy lifting in the attempt to boost oil prices, which is essential to sustain Russia’s invasion of Ukraine.
Unhappily for both, particularly for the Saudis, their sacrifices have yet to yield materially positive results. But they won’t stop trying.
Costly bromance: The Saudis’ willingness to shoulder most of the burden of recent production cuts might owe something to the deepening relationship between Vladimir Putin and Crown Prince Mohammed bin Salman.Credit: Alex Ellinghausen
Earlier this week, Saudi Arabia and Russia announced yet another round of production cuts or, in the Saudis’ case, an extension of an existing cut aimed at pushing oil prices up.
The Saudis said they would extend the million-barrels-a-day cut announced in early June beyond its planned one-month duration into August. The Russians said they would reduce their oil exports by 500,000 barrels a day, with similar-sized cuts to production.
These are the latest in a string of attempts to tighten the supply-demand equation in the oil market, with OPEC+ announcing a 2 million-barrels-a-day cut last October, a 500,000-barrels-a-day cut announced by Russia in February, a further 1.6 million-barrels OPEC+ reduction in April and then Saudi Arabia’s one-month million-barrels-a-day cut last month.
All those production cuts have been to little avail, with the oil price, which briefly traded above $US87 a barrel in early April, trading below $US75 a barrel before the latest announcements. On Tuesday, oil rose about 2 per cent to close at just over $US76 a barrel.
The price briefly blips up, and then falls back.
That’s a familiar response to the series of production cut announcements. The price briefly blips up, and then falls back.
There’s no reason to believe this time will be much different. The forward curve provided by futures trading shows traders expect oil prices to be materially lower at the end of this year than what they are today.
There are good reasons why that might be the case, despite OPEC+’s best efforts. The global economy keeps slowing and China’s economy keeps surprising on the downside, challenging the OPEC thesis that there would be a resurgence in demand for oil in the second half of the year.
The most recent manufacturing industry data out of China, the June manufacturing purchasing managers’ indices, shows factory activity contracting for the third consecutive month. Domestic consumption remains brittle, urban youth unemployment high, foreign investment is falling away and exports and export orders have been shrinking.
It is conceivable that China will roll out a major stimulus package to try to ignite growth, but without a pick-up in global activity that boosts demand for its exports, the likely impact on demand for oil would be modest at best, particularly as it appears China has been using the opportunity provided by cheap sanctioned Russian oil to build its oil reserves.
The Saudis want higher oil prices because they need, according to the International Monetary Fund, a price of about $US80 a barrel to balance their budget. Their willingness to shoulder most of the burden of recent production cuts might also owe something to the deepening relationship Saudi Crown Prince Mohammed bin Salman has built with Russian President Vladimir Putin.
Russian oil is subjected to a G7 (plus Australia) price cap of $US60 a barrel designed to maintain an incentive for the country to keep producing (to avoid a shortfall in global supply), while squeezing the amount of revenue its oil sales generate.
The strategy behind the G7 approach has been broadly effective, despite Russia employing a number of sanctions-busting techniques, with Russia’s oil and gas revenues down 36 per cent in May, relative to May last year.
Russia’s desperation to generate revenue to sustain its war efforts means that, while it announced the 500,000 barrels-a-day cut to production in February, there have been no signs of that cut in the market or in Russia’s export numbers. Russia’s oil export volumes have risen solidly this year, even as Russian officials have claimed they were abiding by their pledge.
The discrepancy between the Putin regime’s words and its actions have generated some tension between the Saudis – who have sacrificed a lot of revenue by delivering the bulk of OPEC+’s production cuts – and the Russians. There are reports that, as part of the agreement to the latest cuts, Russia has agreed to greater transparency around its production and exports.
Its preparedness to carry most of the burden of the attempt to tighten the oil market is costly for the Saudis.
The lost production in July and August represents about $US4.5 billion ($6.7 billion) of foregone revenue for the kingdom, which is in the midst of an extraordinarily ambitious program to transform its economy to reduce its dependence on oil in a decarbonising world.
The Saudis indicated this week that, if necessary, the current reductions could be extended, which would further increase the opportunity costs, which go beyond the most recent production curbs. This time last year, they were producing almost 11 million barrels a day. Today Saudi Arabia’s output is only about 9 million barrels a day.
It isn’t just the reduced revenues. With Europe, its former key market for oil and gas, largely closed to direct deals, Russia has flooded Asia – China and India in particular – with its sanctions-discounted oil.
Earlier this year, Russia overtook Saudi Arabia as the biggest oil supplier to both China and India, with the overwhelming majority of its exports going to those two countries.
The Saudis and other Middle Eastern producers have been forced to redirect their displaced oil shipments to Europe, which is a higher-cost destination to service than Asian markets.
Can the Saudis trust the Russians? With the rest of OPEC sitting out the latest rounds of production cuts – some have, along with some non-OPEC producers, increased their output – they probably don’t have a choice, even if the Russians fail to live up to their latest commitments.
If the OPEC-leading Saudis don’t play the role of swing producer when demand and when oil prices are weak, even when forced to act alone, they lose a lot of regional and geopolitical influence – and there’d be damaging question marks about OPEC’s future relevance as it continues to fail with its attempts to balance supply and demand.
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