Saudi Arabia’s strategic pivot is about letting go of the illusion of market control and moving production back up toward capacity, which will provide more revenue in the long-term.
At a brief online meeting on May 3, OPEC+ decided to again surprise the market with a bit more supply, raising its quotas for June by 411,000 bpd. This, once again, accelerated the pace of phasing out the years-long production cuts which have been in place in various forms since 2020.
This came despite the fact that Brent crude oil closed around $61 per barrel the previous day, and WTI was around $58.
Unlike the previous surprise a month earlier, which led to a sharp selloff, this one did not come as much of a shock to the market. It underscores the fact that after trying to restrict the oil supply for most of the period since 2016, except for a brief price war with Russia in 2020 during the COVID-19 pandemic, the Saudis are once again accepting that they will end up a “price taker” – and that this is the revenue-maximizing strategy over the long-term.
The rhetoric in recent months has downplayed the shift – since nobody wants to admit the failure of one of Crown Prince Mohammed bin Salman’s (MBS) signature initiatives: a more activist OPEC+. Instead, it has been dressed up as a cudgel against OPEC+’s cheaters, particularly Kazakhstan, which has produced more than 400,000 bpd over its quota, and Iraq. But the talk of forcing “compensation cuts” on them has ebbed in recent months.
What has changed is that producers, including Saudi Arabia, have let go of the notion that global demand growth will be strong enough to open up a gap for OPEC+ to expand into. Instead the “call on OPEC+” has stayed relatively flat in recent years, as non-OPEC+ supply has expanded fast enough to fulfill the relatively weak increases in demand.
The data for electric vehicle sales in China for 2024 was really the last nail in the coffin for the strong demand theory that was OPEC+’s institutional view earlier this decade. Global demand is no peaking yet, but if you accept the notion that China is peaking now, it becomes very hard to see demand growth at a rate of over one million bpd in the next few years.
Letting go of an activist OPEC+ policy has been difficult for Saudi Arabia and MBS. The oil price increases of 2017 were seen as an early success for him during his first year, which was after he pushed aside his rival Mohammed bin Nayef and became Crown Prince and the de facto ruler. The idea that higher oil prices would pay for the kingdom’s extravagant “megaprojects” was a core tenet of his Vision 2030 economic diversification plan. Even as the market began to falter under strong supply growth from the United States, Guyana, and Brazil in 2023, Saudi policy doubled down. Saudi Oil Minister Abdelaziz bin Salman, MBS’s half-brother, surprised the market with his awkwardly-named “lollipop” of an additional unilateral one million bpd production cut at the June 2023 OPEC+ meeting.
But it comes down to whether the Saudis take a short-term or long-term view of revenues, and if they that non-OPEC supply growth can fill the demand growth absent additional OPEC+ supply.
Sure, cutting production can increase prices, but if the gap fills in, then the market will come back to the same equilibrium price level based on the cost plus the rate of return of the marginal cost barrel of oil – which is basically U.S. shale at this point. If you posit that equilibrium is $65-70 per barrel, then are you better off selling eight million bpd or ten million bpd?
The current policy shift is about letting go of the illusion of market control and moving production back up toward capacity – not all the way, but closer – which will provide more revenue in the long-term despite needing to absorb a drop below equilibrium prices in the short-term.
About the Author: Greg Priddy
Greg Priddy is a Senior Fellow at the Center for the National Interest and does consulting work related to political risk for the energy sector and financial clients. Previously, he was director of global oil at Eurasia Group and worked at the U.S. Department of Energy.
Image: Shutterstock/Corona Borealis Studio
