The last clear target price Saudi Arabia set for oil was USD 100/bl and that was articulated last March when the Brent price was approaching USD 130/bbl. At the time, Saudi production was still increasing to around 10mmb/d which marked the recent high (Figure 1) and, in our view, was key to transforming 2012 into a surplus year for oil markets and ultimately moderating the oil price.
However, Saudi production began to ease off from mid-summer and fell sharply from October, despite Brent being above USD 100/bbl since mid-July. The drop in Saudi production has been instrumental in reducing OPEC output and, in our view, has made a significant contribution to tightening markets by more than seemed likely at the end of last year. That is probably also a significant factor behind the current strength in Brent, we expect.
Saudi Arabia has explained the reduction in its output as relating to lowered customer demand and the IEA has highlighted the large seasonal swing in domestic demand once the summer heat abates, cutting domestic power demand for air conditioning and hence the domestic demand for crude burning in power generation. Ibrahim Al-Muhanna, a senior Saudi oil advisor, denied in mid-January that cuts in Saudi production were intended to push the price up.
Nevertheless, Saudi actions also leave themselves open to other much more bullish interpretations including increasing its price target, possibly for budgetary reasons, or even difficulty in maintaining production levels, despite the Kingdom’s claim to have 12.5mmb/d of production capacity.
While maintaining an open mind to other possibilities, we suspect that Saudi Arabia has been trying to engineer a soft landing for oil prices toward its target price, fearing the large apparent over-supply in the market might cause a precipitate price drop. Instead it has found that trying to micro-manage the oil price via changes in output has proved impossible, not least because of the variability in output from other OPEC members.
A key litmus test will be what Saudi Arabia does now. The answer to that might lie in its pricing policies. Increasing flows of Saudi production are moving east and it is notable that the drop in production coincides with a sharp increase in premia to the Oman/Dubai benchmark that Saudi Arabia uses to price Asian deliveries.
That was cut sharply for March which we think will incentivise an increase in customer demand. However, if Saudi Arabian volumes do not increase while Brent remains well above USD 100/bbl, the odds will increase on more bullish interpretations being correct, we expect.