Saudi cannot escape destiny as swing producer: Analyst

Saudi Arabia has been forced to return to the role of swing producer in the oil market, despite the country’s insistence for three decades it would never play the role again. Saudi Arabia and its allies in the Gulf Cooperation Council (GCC) account for the majority of production cuts made so far under the OPEC and non-OPEC accords reached in November and December.

By cutting their own output deeply, Saudi Arabia and its allies have masked the low level of compliance from the rest of the organization. Outside OPEC, Russia has so far delivered only around a third of its promised cut of 300,000 barrels per day (bpd), according to sources.

Russia and other producers have always pledged to phase in cuts, which are meant to be averaged over the first six months of 2017. Strictly speaking, OPEC and nonOPEC members have not yet failed to honor their promises since they could reduce output more steeply in the remainder of the compliance period. But Saudi Arabia and its GCC allies have once again supplied most of the upfront cutbacks, reducing their production by enough to create a deficit in the market and draw down excess crude inventories.

Adjusting production to bring about a desired balance between supply and demand, or achieve a particular target price, is the classic role of a swing producer. Saudi Arabia has been forced back into the role, despite insisting since the mid-1980s it would never assume the burden again.

Saudi Arabia only officially played the role of swing producer for a short period in the early 1980s, when it failed to stem the oversupply of global oil markets and slide in prices. The Organization of the Petroleum Exporting Countries began setting an overall production target and allocating it among members at its ministerial conference in March 1982.

The initial target for the group as a whole was set at 17.5 million bpd and Saudi Arabia’s share was set at 7.150 million bpd. One year later, in March 1983, OPEC revised the allocation system and Saudi Arabia formally assumed the role of swing producer, varying its output to balance supply and demand.

Ministers agreed “to establish a ceiling for total OPEC production of 17.5 million barrels per day, within which individual member countries were allocated,” according to the communique issued afterwards. “No quota is allocated to the Kingdom of Saudi Arabia, which will act as a swing producer to supply the balancing quantities to meet market requirements” (“Communique by OPEC”, New York Times, March 1983).

Saudi Arabia had often acted as an informal swing producer, but this was the first time the role had been formalized. Saudi Arabia’s role as a swing producer formally terminated in 1984 when it opted instead for a quota of 4.35 million bpd, though in practice it went on performing the swing producer role until September 1985.

“I have a strong feeling that this will work out and that OPEC will be in the driver’s seat,” Saudi oil minister Zaki Yamani told a news conference after the March 1983 meeting.

But the following three years proved difficult for Saudi Arabia as other OPEC members cheated on their quotas, rival suppliers outside OPEC continued to raise their output, and oil prices fell. Saudi Arabia cut its output to balance the market and shore up prices to no avail, and then switched to a netback pricing system to recapture lost market share, sending prices tumbling to $10 per barrel.

NEVER AGAIN

Yamani was sacked in October 1986 and replaced as Saudi oil minister by Hisham Nazer, who ruled out any return to acting as a swing producer (“Nazer rules out swing producer role for Saudi Arabia”, Middle East Economic Survey, Sep 1987). “We will conscientiously support OPEC ... but we will not appoint ourselves custodians of the policies of OPEC, nor will we be willing to play the role of swing producer at all”, Nazer said in an interview in September 1987.

Nazer’s successor as oil minister, Ali Naimi, was even blunter: “Saudi Arabia tried in the past to play the role of the swing producer by reducing production to maintain a specific price, but the result was unfavorable to the kingdom,” he said in an interview in March 1998.

“Despite the fact that its production fell from more than 10 million bpd in 1980 to less than 3 million bpd in 1985, prices collapsed. As a result, the kingdom not only lost in terms of prices but also lost its market share at that time.”“We have abandoned once and for all the role of swing producer,” Naimi said (“Saudi oil minister spells out kingdom’s views on current oil market”, Middle East Economic Survey, March 1998).

NO ESCAPE

In practice, giving up the role of swing producer has proved impossible, however much the country’s policymakers loathe it. In March 1999, Saudi Arabia was again taking the lead in cutting production to shore up prices after the Asian financial crisis.

Saudi Arabia and its GCC allies ended up providing most of the production cuts that helped drain excess stocks and push prices higher in 1999 and 2000. —Reuters