By Alex Kimani of OilPrice.com

The oil price rally has reversed again after reports emerged that OPEC’s biggest oil producer, Saudi Arabia, is rumored to be looking to accelerate the process of unwinding its oil production cuts. The Brent forward curve has taken a circuitous path in September, going from significant backwardation at the end of August to flat on 10 September; this has been followed by a gradual recovery and steepening up to 24 September and then another flattening. 

The oil futures markets continue to be strongly bearish: 3 days ago, the Wall Street Journal reported that the number of short positions held by money managers in Brent futures has exceeded the number of longs for the first time on record thanks to prospects of more OPEC+ crude hitting markets in the near future.

Last week, the Financial Times reported that Saudi Arabia was ready to abandon its unofficial price target of $100 a barrel for crude oil as it prepares to increase output, effectively signaling that it is resigned to a prolonged period of lower oil prices. 

Previously, Saudi Arabia and seven other OPEC+ members were due to unwind long-standing production cuts from the start of October. However, a two-month delay sparked speculation over the timing of the production increase, with Brent prices dropping below $70 per barrel on renewed demand fears and a weak Chinese economy. FT reported that the kingdom was now committed to bringing back that production as planned on December 1 regardless of market conditions and oil prices at the time as the country tries to avoid more market share to non-OPEC producers including the United States.

There are plenty of detractors, however, including OPEC, which denied earlier this week that it had a new price target. 

Still, the Saudi rumors are certainly worrisome for oil markets given the outsized role the country has been playing as OPEC’s key swing producer. Indeed, Saudi Arabia currently accounts for 2 mb/d out of 2.8 mb/d output cuts from OPEC members and a total of 3.15 from OPEC+. Essentially, the Saudi contribution is double that of the entire group, with only the Kingdom and Kuwait currently cutting production by a double-digit percentage. In fact, a big part of lower output by other OPEC+ members is not voluntary but rather reflects their inability to meet their quotas.

However, commodity analysts at Standard Chartered have taken a more nuanced view of the unfolding situation. According to StanChart, Saudi Arabia’s 84 thousand barrels per day (kb/d) output increase each month starting December 2024 does not necessarily mean that the Kingdom has changed policy and is aiming for market share, pointing out that Saudi Arabia has not had a price target for many years. In StanChart’s view, the major underlying story is that Saudi Arabia is sending a warning that it will accelerate the phasing out of voluntary cuts unless all partners involved fulfill their pledges. StanChart views the latest move by Saudi Arabia as one of several warnings it has issued in recent times to any country seeking to free-ride on the compliance of others.

Compliance with pledges will be key in determining whether oil markets remain tight or not.

Back in July, Russia, Iraq and Kazakhstan submitted their compensation plans to the OPEC Secretariat for overproduced crude volumes for the first six months of 2024. According to OPEC, the entire over-produced volumes will be fully compensated for over the next 15 months through September 2025, with Russia ‘paying back’ a cumulative 480 kb/d, Iraq 1,184 kb/d and Kazakhstan 620 kb/d. According to StanChart, the compensatory output cuts by the three OPEC members work out to a combined 370 kb/d reduction in October, and then an amount varying between 162 kb/d and 206 kb/d for November 2024 through to September 2025. StanChart has worked out that adding the compensation schedule to the recently announced reduction in targets due to delaying the implementation of tapering will result in OPEC production clocking in at 530 kb/d lower in Q4-2024; 540 kb/d lower in Q1 and Q2-2025 and 560 kb/d lower in Q3-2025, if all commitments are kept.

StanChart has argued that the market’s current assumption that there will be no compensation reduction is wrong because it’s highly unlikely that other OPEC+ countries would take it lightly. StanChart says Saudi Arabia is unlikely to accept any further backsliding on promises made by the overproducers, noting that the high-profile visits to Iraq and Kazakhstan by the OPEC Secretary General, Haitham al Ghais suggests that OPEC intends to follow up on the promised cuts.

“I received strong assurances that Iraq continues to be fully committed to the DoC’s ongoing market stabilization efforts. During this visit, Iraq presented clear and determined steps to compensate for overproduced volumes and gave assurances that it would achieve full conformity going forward, ”al Ghais said after visiting Baghdad.

Budget Deficit

It’s unlikely that Saudi Arabia would be too brash with its pace of unwinding given the country is already facing a significant budget deficit at current oil prices. After enjoying a rare budget surplus in 2022, most Gulf Cooperation Council (GCC) economies are seeing their budget deficits widen with current oil prices still well below what they require to balance their budgets. 

According to the IMF, Saudi Arabia, the GCC’s biggest economy, needs an oil price of $96.20 per barrel to balance its books, thanks in large part to MBS’ ambitious Vision 2030. The situation is not helped by the fact that over the past few years, the oil-rich nation has borne the lion’s share of OPEC+ production cuts. The kingdom is currently pumping 8.9mn b/d, the lowest level since 2011. In effect, Saudi Arabia has been selling less oil at lower prices, thus compounding the revenue shortfall.

That said, the Saudis can still afford to inflict some pain on oil markets. As OilPrice.com contributor Irina Slav has noted, Saudi Arabia can simply slam the brakes on Vision 2030, maybe turn it into Vision 2040 or even Vision 2050 if oil markets refuse to cooperate. Further, FT has reported that Saudi Arabia believes it has enough alternative funding options to weather a period of lower prices, including tapping foreign exchange reserves or issuing sovereign debt.

In the final analysis, oil markets will simply have to wait before they decide to call Saudi Arabia’s bluff. Thankfully, the Covid-era oil crisis and oil price crash whipped OPEC+ into shape and many producers have maintained impressive production discipline ever since. It’s unlikely they will be willing to engage in another race to the bottom by flooding the markets with oil.