Saudi Arabia’s Decision to Cut Oil Production: What You Need to Know

Saudi Arabia's stunning decision to cut oil production
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Summary

On Sunday, the world was taken by surprise when Saudi Arabia, and a handful of other countries, announced a significant reduction in their oil production, amounting to over a million barrels per day, starting in May.

Unlike customary, negotiated OPEC+ agreements that are typically reached at regularly scheduled meetings, this decision was unexpectedly and abruptly announced. The United Arab Emirates and Iraq were among the other producers who joined Saudi Arabia in this decision, which has sent shockwaves throughout the global energy market.

“It was a massive surprise to everybody in the market,” says Jorge Leon, a senior vice president at Rystad Energy.

A move that could raise prices worldwide

As soon as word of the reduction spread, the world benchmark, Brent prices, rose $5 to about $85 per barrel. Reduced oil output results in a smaller market supply, which inevitably raises prices.

The impact on oil prices is also anticipated to continue a long time because the cuts are set to take place from May through the end of the year.

“Overall, we think that oil price says might increase by around 10% going forward compared to what we had,” says Leon, of Rystad Energy. “That’s a significant increase.”

Precautionary measure aimed at supporting the stability of the oil market

The instability in the banking industry last month was a major factor in the dramatic decline in crude prices. That has a negative impact on the budgets of nations like Saudi Arabia that depend on oil sales. Additionally, reducing production was a surefire method to raise costs once again.

The reduction, according to Saudi Arabia, were a “precautionary measure aimed at supporting the stability of the oil market.” The kingdom regularly contests the claim that decisions about production are made with a particular price target in mind.

The unexpected production cuts, however, were seen by oil analysts as a strong indication that Saudi Arabia and its partners were establishing a floor for crude oil prices beyond which they would take action to support them.

Fuel Costs are expected to go up

Gasoline prices are significantly influenced by the price of crude oil, thus when the price of oil increases, gasoline prices typically follow, sometimes a few days or even a few weeks later.

That’s what happened in the past year, when the price of oil skyrocketed and the national average for gasoline reached a record-high of up to $5 per gallon.

According to AAA, prices had drastically decreased since then, reaching $3.50 per gallon.

There are currently a number of variables at play, such as refinery outages, fluctuations in demand, and general economic conditions, making it difficult to anticipate with precision how much prices will climb.

The cuts come amid tensions with Saudi Arabia

The alliance between Saudi Arabia and the U.S. has been longstanding, but recent decisions made by the kingdom and OPEC+ regarding oil production and prices have strained the relationship.

Last year, President Biden visited Saudi Arabia to request an increase in oil production in an effort to lower gasoline prices. However, the request was denied.

The latest cuts in oil production have been deemed unwise by the Biden administration, as stated in their official statement.

In recent times, Saudi Arabia has been forging stronger economic and diplomatic ties with China, including through oil deals.

According to analysts from RBC Capital Markets, who have visited Riyadh on multiple occasions in recent months, the Kingdom of Saudi Arabia now views the U.S. as merely one among several partners, while their relationship with China is becoming increasingly significant.

“China is already the Kingdom’s most important trading partner and the country’s economic future is seen as residing in the East,” they wrote.

For U.S. oil companies, this is a boost – and an opportunity

The United States is both the world’s largest consumer and producer of oil. As a result, increasing oil and gasoline prices have a significant impact on American wallets. On the other hand, a production cut by Saudi Arabia can provide a big financial boost to companies that sell crude, as evidenced by the surge in energy stocks on Wall Street on Monday.

Although this presents a potential opportunity for American oil producers to increase their output and capture more of the market, there are several factors limiting their production at the moment. The Dallas Fed’s quarterly survey of oil companies revealed difficulties in raising funds and hiring workers, cost inflation, frustration with the government, disruptions caused by climate activists, and overall uncertainty. Despite President Biden’s criticism of oil companies’ lack of effort in raising production, these obstacles make it challenging for the industry to capitalize on the Saudi production cut.

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