Saudi Arabia faces a difficult balancing act as it tries to work down excess global crude stocks while protecting relationships with important refining customers in the United States and Asia.
Saudi Aramco exports most of its crude direct to refiners under long-term contracts that prohibit resale to other refiners or independent traders.
Aramco’s business has been built around nurturing strategic relationships with customers and emphasising its reliability as a supplier.
The model is very different from most other OPEC and non-OPEC producers that rely more heavily on spot sales to refiners and traders.
Aramco’s strategic relationships and term contracts help it realise value in the long run but reduce its flexibility in the short term.
And Saudi Arabia’s commitment to reduce production under the accord with other OPEC and non-OPEC countries reached towards the end of 2016 creates a tension with its customer-focused strategy.
The kingdom has an obvious interest in reducing excessive global crude stockpiles in an attempt to push oil prices higher.
In fact, Aramco has so far cut production even more than required under the OPEC/non-OPEC agreement to accelerate the rebalancing process.
But Aramco is also keen to protect is preferential-supplier status with refiners across Asia and the United States which means protecting volumes as far as possible.
Contracts with refiners contain some limited flexibility to vary the volume supplied each month which allows for some adjustment.
But Saudi Arabia does not want to cut its own supply if the shortfall will simply be made up by increases from other exporters producing similar crude oils.
Iran, Iraq, Oman and Russia all produce medium and heavy sour crudes with similar characteristics to Saudi crude.
For that reason, the kingdom insisted they were all bound by production limits in the OPEC/non-OPEC agreement.
But even with the OPEC/non-OPEC agreement, it is still difficult to cut exports without leaving important customers disappointed and looking for alternatives.
PRODUCTION AND SUPPLY
The challenge is how to cut output without reducing exports too much.
One option is to cut domestic consumption, which the kingdom has been doing by increasing gas production and reducing crude consumption in its power plants.
The problem is that a reduction in direct domestic crude consumption is equivalent to an increase in global oil supply and makes the rebalancing process slower.
Another option is to run down domestic crude stockpiles, though that is obviously unsustainable in the long term.
Saudi Arabia cut production by 482,000 barrels per day (bpd) in January 2017 compared with the same month a year earlier, according to government figures supplied to the Joint Organisations Data Initiative.
But exports were cut by only 122,000 bpd compared with the same month in 2016, according to JODI data, which is likely one reason that OECD crude stocks have been slow to fall.
Direct crude consumption by the power sector fell by around 40,000 bpd while refinery intake was reduced by around 340,000 bpd.
Even so, domestic crude stocks fell by almost 11 million barrels in January. Stocks have fallen in 13 of the last 14 months by a total of 67 million barrels as exports and domestic consumption have outstripped production.
The drawdown in January was the second-largest in the last five years and was obviously unsustainable for any length of time.
In response, the kingdom boosted production by 263,000 bpd in February, which left output just 209,000 bpd below year-earlier levels, according to government data supplied directly to OPEC.
But the independent assessors surveyed by OPEC reported output declined by a further 90,000 bpd, a discrepancy that prompted the Saudi energy ministry to issue a rare clarification:
“The difference between what the market observers as production, and the actual supply levels in any given month, is due to operational factors that are influenced by storage adjustments and other month to month variables.”
Saudi Arabia expects its crude oil supply to be stable at around 10 million barrels per day in the next few months, fully in line with the country’s OPEC quota and regardless of possible fluctuations in monthly production, industry sources told Reuters on Thursday.
SUMMER EXPORT LEVELS
Saudi Arabia’s internal consumption is set to rise significantly in the months ahead as its refineries complete scheduled maintenance and direct crude burn in the power sector increases in the summer months.
If production remains unchanged, the volume available for export should decline during the second and third quarters of 2017, which would help drain global crude stocks and tighten the market.
Many oil traders have been assuming a sharp drop in Saudi exports, which is one reason why calendar spreads from June onwards have narrowed significantly.
But any reduction in exports would leave refiners in Asia and the U.S. Gulf Coast short of feedstock and hunting for Russian and other Gulf crudes to fill the gap.
Rising domestic crude consumption will sharpen the tension between Saudi Arabia’s price-management and customer-relationship objectives.
It will also test the newfound solidarity among OPEC and non-OPEC producers as they try to coordinate to drain stockpiles while also competing to protect market shares.