OPEC Raises The Ceiling

Saudi Arabia Tests The Power Of Production Cuts

Saudi Arabia and Russia together managed to trim oil production enough to put a floor price under oil, finally getting the price of benchmark Brent crude to stabilize above $80/bbl.

OPEC Finds Oil Price Floor...And Ceiling?

Unfortunately for the desert kingdom, world events conspired to also quickly establish a ceiling price for oil near $87-$88/bbl. Now Saudi Arabia is extending its production cuts to at least October 1.

Saudi Arabia will likely roll over a voluntary oil cut of 1 million barrels per day for a third consecutive month into October, five analysts said, amid uncertainty about supplies and as the kingdom targets drawing down global inventories further.

OPEC+, which groups the Organization of the Petroleum Exporting Countries and allies led by Russia, agreed a broad deal in early June to curtail supplies until the end of 2024. Saudi Arabia at the time announced the additional voluntary cut which brought its oil production to a multi-year low of 9 million bpd.

After this assessment came out August 23, the Energy Information Administration announced a larger than usual weekly drawdown of oil inventories at 6.1 million barrels. Prices for Brent crude began rising again, peaking roughly $1/bbl above the previous ceiling set earlier in the month.

Saudi Arabia appears to be testing how solid the ceiling price is, particularly in the wake of global inventory drawdowns. How high will they be able to push the ceiling price on Brent crude by extending the production cuts?

When Saudi Arabia extended the production cuts into September at the beginning of August, the markets had a minimal reaction. Price drifted up for a few days before peaking August 9 at $86.04/bbl.

Over the past twelve days, the price of oil has steadily climbed back towards that ceiling price, finally breaching it on Friday, closing at $87.80/bbl. Whether there is enough upward pressure in prices to push them even higher remains to be seen.

The primary catalyst for the price rises has been drawdowns of oil inventories. In the most recent Energy Information Administration weekly report, US crude inventories were drawn down by 10.6 million barrels. This came on top of a 6.1 million barrel draw the week before.

According to the American Petroleum Institute, last week’s crude draw was 11.5 million barrels, an amount far in excess of what had been projected.

The American Petroleum Institute (API) has reported a massive 11.486-million-barrel draw in U.S. crude inventories, compared with the previous week's 2.418-million-barrel draw as the markets weigh China's economic activity against U.S. crude inventories.

Analysts were expecting an inventory draw of 2.9 million barrels for the week. The total number of barrels of crude oil gained so far this year is just shy of 4 million barrels, according to API data, although there is a net draw in crude inventories since April of almost 44 million barrels.

Intriguingly, although the combination of oil draws and production cuts has managed to push benchmark Brent crude and West Texas Intermediate back to their recent highs and then beyond, Russia’s Urals crude has not had the same good luck on prices.

Even though Russian crude has thoroughly blown through the EU/G7/NATO price cap imposed on seaborne Russian crude oil, Urals oil prices have not kept pace with this most recent spike in benchmark Brent crude.

While at the beginning of August Urals crude followed Brent, reaching $73.73/bbl, this most recent rise has been more muted, with Urals crude only reaching $71.12/bbl by Friday’s close.

Most likely, this is due in part to India curtailing its oil purchases from Russia.

India's August Russian crude oil imports fell by about 20% from July levels to 1.5 million bpd—and down from 2.2 million bpd in June. Saudi Arabia's crude oil imports rose by 63%.

With Russian crude commanding less of a discount, India in particular is less enthusiastic about purchasing Russian crude, until such time as Russia provides a deeper discount.

"Imports of Russian oil are likely to remain at subdued levels for a couple of months due to lower discounts, and that would force suppliers of Russian oil to provide deeper discounts," Refinitiv analyst Ehsan Ul Haq said on Thursday.

One refinery source told Reuters that discounts on Russian oil for October loading are now less than $5 per barrel. That same source also said that the refinery has yet to place an order for Russian crude oil for October loading.

The discounts for Russian crude oil are small enough now that it is becoming difficult to find Russian crude for less than the $60 price cap imposed by Western sanctions—a reality that could give India pause in those imports.

OPEC crude has labored under a similar difficulty.

Although Saudi Arabia has been successful in pushing up the price of oil, the higher prices have made its oil less attractive to China, in particular.

China, the world's top crude importer, is drawing on record inventories amassed earlier this year as refiners scale back purchases after OPEC+ supply cuts drove global prices above $80 a barrel, traders and analysts said.

Chinese refiners, led by Sinopec and PetroChina, have built a supply buffer using massive storage capacity constructed over the past decade that gave buyers flexibility to boost purchases when prices are low and cut back when oil becomes expensive.

This is always the Achilles Heel of any effort by OPEC to manipulate global oil prices by manipulating global oil supply—when prices are low major oil consumers such as China can and will use the low price to buy more oil than for which they have demand, and then use the accumulated inventory to buffer oil purchases so as to minimize exposure to high prices. As the world’s leading importer of crude oil, China’s oil inventory strategy is possibly sufficient to minimize how much tightening of supply is achievable under Saudi Arabia’s production cut strategy.

"China built up the stocks to run them down when it wanted to avoid the overheated market of July-August," said Kpler analyst Viktor Katona.

"As a tactical move, it worked well because they've avoided the $85+ per barrel environment for large-scale purchases."

Adi Imsirovic, director at energy consultancy Surrey Clean Energy, estimated China bought about 750,000 to 1 million barrels bpd of crude just for storage in the first half of 2023.

"With prices at at least $85 and above, China will not buy for storage," he said.

"That will just cancel out what the Saudis are doing."

These are the market behaviors that have converged to produce the ceiling price on oil.

Oil Prices Found Their Floor, And Now Their Ceiling

The ceiling effect is not merely because oil prices have trended down for a week. There are also signs that oil buying patterns have been particularly price-sensitive, and where some countries were buying and stockpiling oil, rising oil prices are now leading them to tap their inventories.

Ironically, and perhaps somewhat counterproductively, the United States has chosen August as the month to begin buying for storage again, adding approximately 2.8 million barrels back into the Strategic Petroleum Reserve.

With oil having risen through the previous ceiling price for the first time since establishing that ceiling, it remains to be seen whether or not Saudi Arabia and OPEC+ can bring enough price pressure to bear through their production cuts to sustain prices above that prior ceiling price.

While Saudi Arabia’s extension of their production cuts will serve to constrain oil supply, China’s deteriorating economy is proving to be a drag on their oil demand, which is easing supply pressures.

China's sluggish post-COVID growth, which has curbed fuel and petrochemical demand, will loom large over both events, while concerns about LNG supplies ahead of the northern hemisphere winter are set to dominate talks at Gastech.

Hopes for a rapid recovery in the world's biggest importer of crude, and second largest buyer of liquefied natural gas (LNG), are fading fast amid elusive policy support, and its record oil inventories key factors in capping global oil prices and Asia's spot LNG prices .

Also frustrating Saudi Arabia’s efforts to push oil prices up is Iran’s increased presence in oil markets, as the US chooses to apply more discretion in enforcing its sanctions on the Islamic Republic.

Iran's oil output and exports jumped in August despite U.S. sanctions, according to consultants and companies that track tanker shipments, as Tehran sells to buyers including China.

Analysts said the higher exports appear to be the result of Iran's success in evading U.S. sanctions and Washington's discretion in enforcing them as the two countries seek better relations.

Iran is, of course, taking advantage of the Saudi production cuts and the current geopolitical environment to sell its own oil, benefiting itself at its Persian Gulf neighbor’s expense.

Which highlights a key strategic flaw in Saudi Arabia’s production cut strategy—lack of firm buy-in by other major oil producers such as Iran. While Saudi Arabia and Russia cut production to boost the per-barrel price, other oil producing nations can easily take advantage of that by boosting their own production.

Will Saudi Arabia be able to boost oil prices further by extending their production cuts for another month? Possibly, but the effect is likely to be minimal and temporary, if only because the production cuts will ultimately be undermined by other oil producing countries such as Iran looking to sell all the oil they can.

The oil price ceiling might wobble, and might even slide up to $88/bbl. It could even flirt with $90/bbl. However, as long as the prices are dependent upon constrained supply, the overarching trend in oil prices will remain downward. Unless demand firms up, the future of oil prices is always going to be lower and not higher.