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Two minute explainer: How Saudi Arabia steers the crude price

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If you want to win a game of Monopoly owning Mayfair and Park Lane really helps, controlling most of the board is even better.

So it is in the market for crude oil, which is among very few markets in where a cartel not only exists but actually has its own flag and holds press conferences.

Saudi Arabia with the highest volumes of crude production and the lowest costs holds the premium spots on the board.

It also leads the OPEC group and along with Russia, for as long as they agree, the Kingdom steers crude price trends.

The United States meanwhile finds itself occupying all the orange and red spaces on the Monopoly board – as it is the high frequency, low return play.

But, lets wrap up this analogy quickly, before we all find ourselves on the hook for Hasbro licensing.

OPEC+ vs America

The emergence of North American shale resources as a plentiful source of hydrocarbons rebalanced the crude market in recent decades but, typically, such operations have more onerous costs because of higher engineering demands.

At a high enough crude price America can produce enough low margin crude to sustain its own domestic demand and even export some excess.

Soaring crude prices of US$100 or more of course balloon margins for Saudi operations, which as a rule of thumb are below US$3 per barrel.

Strategically, however, there are diminishing returns for the Kingdom as oil wells spring up everywhere to mop up marginal returns. It massively dilutes market share for Saudi and other OPEC members such as Iraq, UAE, Iran, Kuwait, and Nigeria.

Russia finds itself with a similar proposition as crude prices climb which consequently sees them allied over oil policy.

Quotas

Managing production volumes is the main lever that Saudi, OPEC and Russia (a collective commonly referred to as OPEC+) can pull to exert some control of crude prices.

By keeping capacity reduced it can put the brakes on price trends and retain market share.

The OPEC+ strategy proved successful in the wake of 2014’s crude market slump and was again the driver in oil’s recovery from the early doldrums of the Covid-19 pandemic, which has largely seen industrial and transport demand wiped out.

Saudi production cuts

Quotas and cuts in 2020 saw the OPEC+ group not produce nearly 10mln barrels of oil per day in order to keep a floor under oil prices.

In January, the cartel agreed they would release another 500,000 barrels per day to unwind curbs as they eyed rising demand as various countries began phased recoveries from pandemic restrictions.

The continued management of the crude supply is expected to underpin crude prices.

Goldman Sachs last week upgraded its target for crude after OPEC+ kept quotas unchanged through April.

Moreover, analysts at Goldman, in a note, said that Saudi is guiding for only a gradual ramp-up of volumes as economies re-open.

At the same time, the American bank highlighted that with crude oil prices up 25% since January and excess inventories reduced by an estimated 56% the cut in volumes is working in Saudi’s favour.

Goldman highlighted that OPEC’s strategy is in contrast with the pre-2020 strategy in which the bank says OPEC viewed itself as ‘the central bank of the oil market’.

“We believe it is now clear that OPEC+ is in fact pursuing a tight oil market strategy.”

A tight-market strategy leaves crude somewhat vulnerable to higher volatility, triggered by outside forces.

Brent crude starts this week on at around US$70 per barrel, for the first time early 2020, after a drone attack on the Saudi port of Ras Tanura, which is among the largest oil shipping locations in the world.

The attack was claimed by Yemen’s Houthi fighters, which said they had fired 14 bomb-laden drones and eight missiles in Saudi.

Saudi, meanwhile, said that the attack “did not result in any injury or loss of life or property” and no oil production had been affected.

Brent crude was up around 3%, trading up to a high of US$71.38, whilst West Texas Intermediary crude gained 1.6% to US$67.17.

Story by ProactiveInvestors



Source: http://www.proactiveinvestors.com/companies/news/943250/two-minute-explainer-how-saudi-arabia-steers-the-crude-price-943250.html


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