Saudi decision to cut oil output more about politics than market

Suddenly, Saudi Arabia is playing nice. The Saudi Crown Prince Mohammad Bin Salman, or MBS, was seen hugging his Qatari Emir (diplomacy trumped social distancing) on Tuesday to break a three-year-old bitter political standoff with its neighbour, and also stepped in to save global oil markets.

At a routine meeting of the The Organization of the Petroleum Exporting Countries and its allies, including Russia, the Saudis made a splash by declaring a unilateral one-million barrel per day cut. Brent crude prices shot up 5 per cent on the news Tuesday, and are rose again Wednesday to hit US$54 per barrel.

“We are the guardian of this industry,” Saudi Energy Minister Prince Abdulaziz bin Salman said as he “gleefully” announced the cut on Tuesday, Bloomberg reported. He underlined the fact that the decision was made unilaterally by his brother, the Crown Prince himself.

Recall that just over nine months ago, the Saudis had taken the catastrophic decision to boost production amid one of the most dramatic collapses in global oil demand, sending oil prices spiralling downward.

But that was then. U.S. President Donald Trump was turning the screws on Iran and decimating its oil exports, and the Saudis had the carte blanche to crush dissent in the most brutal way.

With Washington in the midst of a dramatic political change, Saudi Arabia is now hoping to curry favour with powerful American politicians by boosting prices.

“Was this shot in the arm for the oil market also intended as an olive branch to Washington on the eve of President Trump's departure?,” wrote Helima Croft, head of global commodity strategy, and Middle East North Africa Research.

Saudi Arabia and its allies' economic embargo against Qatar was also a cause for concern in Washington (the United States has a military base in Doha), and with the twin moves, the Crown Prince is hoping to recast himself as a diplomat and erase his well-earned image of a ruthless autocrat.

“Certainly, we think the decision will be applauded by the powerful oil state Republicans,

such as Ted Cruz (R-TX) and James Inhofe (R-OK), who had been highly critical of the Kingdom in the midst of the spring price war,” Croft said.

President-elect Joe Biden's administration will also likely offer some sanctions relief to Iran (Saudi Arabia's arch nemesis), which would see more Persian oil flowing back into the global market. The pre-emptive cuts will ensure that the Saudis can keep markets in equilibrium, Croft thinks.

The Saudi decision even took the Russians by surprise. Energy Minister Alexander Novak had been pushing for 500,000-bpd increase in production and has been annoyed lately by the lack of compliance by OPEC and allies.

Riyadh's move disarmed Moscow, with journalists attending the OPEC virtual meeting noting that Novak even flashed a smile — a rarity from the stoic minister.

Indeed, it is quite shocking that the Saudis are proposing to cut output, as it could effectively mean that they are willing to give up market share, writes Bjornar Tonhaugen, analyst at Rystad Energy.

“What is noteworthy is that the Saudis are going against their previous official stance, by offering to shoulder a cut burden unilaterally — succumbing to the preference of the other strong coalition members such as Russia and the UAE to increase market share — while still being shielded from a possible negative oil price reaction,” Tonhaugen said.

The `Saudi put' reverberated across the world, with stocks of Suncor Energy Inc., Canadian Natural Resources Ltd. and Cenovus Energy Inc. all jumping on Tuesday and continuing their advance on Wednesday.

Even Canadian analysts who have seen their fair share of false dawns seem optimistic about the prospects for Canadian oil this year.

“Despite Saudi's surprise announcement today to continue supporting prices, 2021 is shaping up to be another volatile year for crude, particularly in the first half; however, we see some cause for optimism growing in the back half and gaining momentum into 2022,” wrote Travis Wood, analyst at National Bank of Canada Financial Markets.

Investors should be wary of basing their strategy on the whims of the kingdom. The unilateral decision by the Crown Prince suggests the calculation was political not market-based, and could be turned on a dime if it's politically expedient for the Saudis to do so.

“While Saudi Arabia had an exceptionally good OPEC+ meeting, we are cognizant that sands can quickly shift in this unwieldy producer alliance,” Croft cautioned. “We will be keeping a close eye on Moscow's next moves as we continue to contend that its oil price priorities may increasingly diverge from the rest of the OPEC+ members over the year ahead.”

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