COLUMN-Saudi Arabia resumes familiar role as swing producer: Kemp
(Repeats column without change. John Kemp is a Reuters market
analyst. The views expressed are his own)
* Chartbook: https://tmsnrt.rs/2TYmwu1
By John Kemp
LONDON, Feb 20 (Reuters) - Saudi Arabia has resumed its
traditional role as the swing producer, sharply reducing its own
output to tighten the oil market and push prices higher.
The de facto OPEC leader has demonstrated, once again, that
it can always tighten the physical market, boost prices and push
the calendar spread into backwardation - if it is prepared to
cut its own production enough.
The familiar problem is that protecting prices comes at the
expense of market share: the more the kingdom cuts its own
production and tightens the market, the more it encourages
increased output from other sources.
In this case, rising prices threaten to extend the oil
drilling and production boom in the United States, which would
ultimately force Saudi Arabia to make even deeper cuts or
abandon its price-defence strategy.
Saudi Arabia has never been able to escape from this dilemma
and the country’s oil policy has cycled between a priority on
price defence and volume defence (https://tmsnrt.rs/2TYmwu1).
The kingdom has always struggled to craft an exit strategy
from periods of output restraint. Policymakers pursue production
curbs for too long, tighten the market too much and drive prices
to an unsustainable level.
The result is usually a slowdown in consumption growth and
an acceleration of non-Saudi sources of production that pushes
the market back towards surplus and necessitates a new round of
The kingdom made the same mistake in 2008, 2014 and 2018,
failing to raise production early enough, creating the
conditions for unsustainable price inflation and sowing the
seeds of the subsequent downturns.
Like any oil exporter Saudi Arabia will always benefit from
an increase in prices in the short term, but it can then prove
difficult to put a lid on the market.
Saudi Arabia’s informal price targets tend to ratchet up as
realised prices rise, with its targets tending to be somewhat
In the first nine months of 2018 Saudi Arabia allowed the
market to tighten too much, pushing prices above $80. That
proved unsustainable and triggered a slowdown in consumption
growth and a surge in U.S. shale.
The kingdom's market management was not helped by a
mercurial White House, which threatened to push Iran's oil
exports to zero and then granted generous sanctions waivers.
The question is whether the Saudis will make the same
mistake again in 2019. Experience suggests it will.
Senior Saudi officials have often sought to downplay the
swing-producer tag since the mid-1980s, when the kingdom cut
production even as other countries raised theirs.
They have been keen to emphasise the importance of spreading
cuts across Organization of the Petroleum Exporting Countries
(OPEC) and more recently an enlarged group including Russia and
But the historical record shows that cuts by Saudi Arabia
have been decisive in influencing spot prices and calendar
spreads, and that Saudi Arabia, rather than OPEC or OPEC+, is
the true swing producer.
By cutting its own production, Saudi Arabia has always been
able to engineer a rise in Brent spot prices and push the
calendar spread into backwardation, as the attached charts
The kingdom’s influence is enhanced when the global oil
economy and oil consumption are growing strongly and when the
output of rival producers is disrupted by war, sanctions or
Saudi Arabia has preferred to assemble coalitions of other
producers to maximise its price leverage and for diplomatic
reasons (OPEC and OPEC+ provide a useful shield against
But Saudi output policy has been the primary driver of
market prices and spreads as the kingdom has been the only
exporter with the scale and flexibility to shift the global
The recent round of production cuts, agreed by OPEC+ at the
start of December, has conformed to this pattern (“The 5th OPEC
and non-OPEC ministerial meeting concludes”, OPEC, Dec. 7).
The enlarged group agreed to cut by a total of 1.2 million
barrels per day (bpd) in the first six months of 2019, with
reductions to be shared between OPEC (0.8 million bpd) and its
Russia-led allies (0.4 million bpd).
In the event, Saudi Arabia cut its own output by 380,000
million bpd in January, exceeding its pledged share of 320,000
bpd and accounting for more than half of the total cuts achieved
by OPEC in the first month.
Saudi Arabia’s aggressive reductions have compensated for
poor compliance with the agreement by some other OPEC and OPEC+
members (“OPEC oil output falls by 890,000 bpd in January”,
Reuters, Jan. 31).
The kingdom has gone further and pledged to reduce its
output by more than 1 million bpd from 11 million-plus in
November to only 9.8 million in March, Oil Minister Khalid
al-Falih said in a recent interview with the Financial Times.
The kingdom’s shift has helped to boost front-month Brent
futures prices by more than $15 a barrel (30 percent) since late
December and push the six-month calendar spread from a $1.70
contango to 45 cent backwardation.
The price impact has been assisted by increased optimism
that the global economy will avert recession as well as the
impact of U.S. sanctions on Venezuela’s oil production and
position-building by hedge funds.
PLUS CA CHANGE
Provided that the global economy avoids recession or a
prolonged slowdown this year, the oil market will tighten
progressively over the course of 2019.
Given their approach last year, Saudi Arabia and OPEC+ are
likely to prolong their output restraint until prices are well
above $70, perhaps breaching $80.
The result will be another spurt of U.S. shale production
and a slowdown in oil consumption growth, pushing the market
back towards surplus and necessitating another round of cuts.
If Saudi Arabia and OPEC+ want to halt this cycle of
instability, they need to be pro-active and start relaxing
output curbs gradually as prices climb above $70.
But OPEC has never been great at fine-tuning and the track
record suggests prices are likely to overshoot on the upside to
set the cycle in motion all over again.
- Is Aramco share sale distorting OPEC policy? (Reuters,
March 7, 2018)
- OPEC must think about exit strategy (Reuters, Oct. 25,
- Saudi Arabia cannot escape destiny as swing producer
(Reuters, Feb. 1, 2017)
(Editing by David Goodman)
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