Saudi Arabia, as well as major forecasters, expected oil demand in Q1 to continue to struggle as major economies in Europe and some parts of China are under renewed lockdowns to fight the spread of COVID-19.
The Kingdom’s “wonderful surprise” to the oil industry, as its Energy Minister Prince Abdulaziz bin Salman described the extra cut in a Bloomberg interview, lent support to oil prices while the outlook for Q1 demand continues to deteriorate, due to the spreading virus, strict lockdowns, and a slow start to vaccination programs.
The Saudi ‘generosity’ signals that the Kingdom is willing to forgo short-term market share in order to prop up prices amid weak immediate demand, tighten the market faster, and wait for the opportunity to ramp up production once oil demand rebounds at some point in the second half of 2021.
Yet, in the process, the Saudis would incentivize increased activity in the US shale patch, which could abandon the promised restraint in spending, and increase production. Higher than currently estimated US oil supply could cap oil price gains and ruin the Saudi attempts to tighten the market.
The Saudi cut also signals growing divergence in oil price fixing policies between the two leaders of the OPEC+ pact, Saudi Arabia and Russia. Saudi Arabia looks more eager to see higher oil prices, even at the expense of losing more market share to US shale. Russia, which had pushed for another 500,000-bpd collective production increase from OPEC+ in February, has been wary for years that by cutting its own production and helping to support prices, it is actually boosting US oil output.
International Energy Agency (IEA) has yet again cut its outlook on global oil demand for 2021, including revising down its Q1 demand projection by 600,000 bpd. Therefore, it seems Saudi Arabia has made the right call when it announced the extra one million bpd cut to its production for February and March. In terms of achieving higher oil prices and a tighter market going into the second half of 2021, the Saudi move looks right.
According to the IEA’s monthly report from this week, the OPEC+ group’s “more proactive production restraint looks set to hasten a drawdown in the global stock surplus.”
“Assuming OPEC+ achieves 100% compliance with the latest agreement, global oil stocks could draw by 1.1 mb/d, or 100 mb, in 1Q21, with the potential for much steeper declines during the second half of the year as demand strengthens,” the agency said.
But while Saudi Arabia’s energy minister says, “We are the guardian of this industry,” the Kingdom is (maybe inadvertently) helping US shale by ‘guarding’ the price of oil from collapsing when demand is weak, as it is this quarter.
Analysts, including OPEC and the IEA, say that the higher oil prices—thanks to Saudi Arabia—could provide a reason to the US shale patch to boost drilling activity more than anticipated earlier.
The “wonderful” Saudi gift to support the oil market could hinge on US oil producers resisting the temptation to increase production after WTI Crude prices hit this month US$50 a barrel mark for the first time since February 2020.
US firms “seem committed to pledges made to keep production flat and instead use any price gain to pay down debt or to boost investor returns. If they stick to those plans, OPEC+ may start to reclaim the market share it has steadily lost to the US and others since 2016,” the IEA said in its latest Oil Market Report.
Oil above $50 is set to create a chain reaction in the US shale patch, which could see cash from operations (CFO) rise by 32% this year. Shale producers in the Permian Midland, Permian Delaware, Eagle Ford, Bakken, and DJ basins could see their combined CFO increase to US$73.6 billion in 2021, up from an estimated US$55.7 billion in 2020, but still down from US$87 billion in 2019. Nevertheless, WTI Crude averaging above US$50 and the higher cash flow in the shale industry would allow producers to increase their activity spending.
The higher activity in the shale patch will be necessary just to keep US production flat, but above US$50 oil price could be tempting. Analysts expect a cautious ramp-up of activity, with shale oil production continuing to decline into the second half of 2021. Despite all the compelling arguments for restraint, the industry’s history suggests that increased cash flows generally get turned very quickly into new wells.
