Saudi Arabia might not be as frustrated as one would expect by the oil market’s weakness in the face of a coordinated cut by major global crude producers.
The Saudis are playing a longer game, write analysts at RBC Capital Markets, in a Thursday note. That’s because the key elements of the country’s ambitious Vision 2030 program to wean its economy off oil are 2018 events, notes Helima Croft, RBC’s global head of commodity strategy. That includes the crucial partial listing of state-owned Saudi Arabian Oil Co, known as Saudi Aramco, which could value the firm at as much as $2 trillion.
“This may well explain the lack of urgency to rescue prices this summer and instead, letting the current cut run its course and thus leaving the option to cut more in the tank,” Croft wrote.
In fact, the Saudis may be wary of a scenario in which a 2017 oil rally “destroys the 2018 recovery by facilitating a flood of production from the U.S. Hence, there may be a real advantage in waiting and keeping some moves in reserve,” Croft said.
Brent crude the global benchmark, is down more than 15% year to date, while West Texas Intermediate the U.S. benchmark, is off 14.6%. Both are up by more than 3% this week, however, buoyed in part by a sharp fall in U.S. crude inventories.
Crude’s 2017 slide has been a disappointment for bulls who expected oil to be underpinned by the agreement by the Organization of the Petroleum Exporting Countries and other major producers struck last year and extended this spring to curb production.
Croft’s colleague Michael Tran argued that the Saudis must avoid a replay of the past six months when “U.S. production elasticity proved to be the biggest downside driver of oil prices.” A material price rally that triggers another round of hedging by U.S. producers (see chart below) “is the worst-case scenario for the Kingdom given that it would return U.S. producers to an anti-fragile and price-agnostic state, opening the door for lower prices next year at a time when the Saudis need visibly higher prices the most,” Tran wrote.
In other words, a big rally now would give shale producers the opportunity to lock in those higher prices and maintain or boost production into next year.
Still, events could overtake the Saudis, Croft noted, should increased output by Libya and Nigeria, which have been exempt from the deal on production curbs, prove sustainable heading into the fourth quarter.
That could force Saudi Oil Minister Khaled al-Falih to make good on a May pledge to make more cuts to make room for the volatile producers, she said, while noting that a better outcome would be for the Saudis to find a way to bring the two countries into the production agreement given the lighter grades of crude they produce and the stronger signal such a move would send about “shared OPEC responsibility.”