The Saudi-Russian axis within the OPEC+ alliance of OPEC and non-OPEC oil producers is stronger than ever as the two countries work together to push oil prices higher to augment their respective governments’ revenue. The September 5 decisions by the two OPEC+ heavyweights to extend oil supply cuts by a combined 1.3 million barrels per day through the fourth quarter of 2023 are expected to severely tighten oil market balances and put prices on a solid upward trend toward $100 per barrel. After stabilizing at around $85/bbl in August, international Brent crude oil, the price benchmark for two-thirds of the world’s oil supplies, was trading in a higher range of $93/bbl to $94/bbl over the past two weeks.

Saudi Arabia is providing the lion share of the voluntary supply cuts at 1 mb/d, which it first implemented in June, and has extended these cuts until December. The kingdom has aggressively pushed for higher oil prices this year to boost oil revenue needed to meet the country’s ambitious spending projects and shore up its economy. Russia’s supply curbs via reduced oil exports account for a much smaller 300,000 b/d. The increased revenue will help bolster its sanctions-hit budget and fund its war chest for the protracted military campaign in Ukraine.

A day after the announcement, when prices breached $90/bbl to 10-month highs, Russian President Vladimir Putin and Saudi Crown Prince Mohammed bin Salman praised their bilateral collaboration within OPEC+ in a telephone call, according to a press release by the Kremlin. It “noted that specific agreements on reducing oil production, combined with voluntary obligations to limit raw materials deliveries, made it possible to stabilise the global energy market.” The two leaders also committed to “further deepening cooperation.”

The increasingly strong working relationship and shared agenda between the two countries may be more than a little disquieting to many global leaders, not least because of the power they hold over global oil markets. Saudi Arabia and Russia, the two largest producers in OPEC+, control a substantial 43% of the 23-member bloc’s output of 42.8 mb/d, according to data from the International Energy Agency. The OPEC+ alliance, led by Saudi Arabia, provides over 40% of total global oil supplies and holds the only spare production capacity available in the world, which underpins its leverage over oil price levels.

A Question of Semantics

But rather than stabilizing the market, prices have spiraled higher toward the $100/bbl threshold in the wake of the announcement. There is a broad consensus in the market that the latest decision to withhold production at a time of record global demand and low inventories is a move by Saudi Arabia to accelerate oil prices higher and capture increased revenue. OPEC officials never talk about price aspirations, and press releases consistently assert the group is supporting market stability, which to most oil analysts has become synonymous with higher prices.

Saudi Energy Minister Prince Abdulaziz bin Salman defended the kingdom’s decision at the World Petroleum Congress in Calgary. “It’s not about …  jacking up prices, it’s about making the decisions that are right when we have the data,” he said. The minister argued that there are many uncertainties about the global economy and sustainability of strong oil demand. He argued that the “jury’s still out” on the recovery in economic growth in China, Europe, and the United States as well as central bank actions to temper inflation. The Saudi minister’s view appears to contradict forecasts from major international organizations, including by the OPEC Secretariat, as well as consulting companies and investment banks, but it may also reflect a more cautious outlook. Rather than relying on forecasts, he said that he needed to see “real numbers” that support market tightness, especially for China, before making further decisions.

The agreement to “stabilize the market” may also appear a misnomer to government leaders of oil consuming countries concerned that the latest surge in oil prices will increase inflationary pressures on the fragile global economic recovery. The rise in prices complicates efforts by central banks to tame inflation and raises the prospect that they could hike further already high interest rates or delay the unwinding of them to the detriment of some struggling countries. Financial markets have also been rattled by the potential impact on the U.S. Federal Reserve’s rate hike policy. After easing to a 2023 low of 3% in June, U.S. inflation in August accelerated for a second straight month, to 3.7% from 3.2% in July.

Higher interest rates have had a ripple effect on global economies by increasing the costs of goods and services, which has cooled spending and curbed international trade. Analysts say the steep rise in oil prices is affecting everything from gasoline and other transportation fuels to manufacturing and supply chain costs. Higher oil prices since June, which are a key input into inflation, have been further fueling inflation. In the United States, August consumer inflation increased by the most in 14 months on high fuel costs, with gasoline prices, which jumped 10.6%, accounting for more than half of the 0.6% monthly rise in the Consumer Price Index. U.S. West Texas Intermediate crude prices reached an 11-month high, to over $92.50/bbl September 19.

Saudi Arabia’s and Russia’s supply cuts also impact inflation because the loss of their distillate-rich oil crudes has left refiners struggling to source similar quality crude needed to produce enough middle distillate products, such as heating oil and, crucially, diesel fuel that is used in ships, trains, and trucks and needed to power industries, manufacturing, construction, and agriculture operations, among many other critical uses that fuel economies. Diesel futures prices jumped to $130/bbl to $140/bbl by mid-September, some $35/bbl to $45/bbl above the price of crude.

Further flaming inflation fears, on September 20 Russia announced that it was temporarily banning all exports of diesel fuel and gasoline. Russia is a substantial exporter of diesel supplies, at around 1 mb/d. Europe was the primary market for the country’s exports prior to the implementation of European Union sanctions on Russian crude and refined product imports, though Russia had since redirected those supplies to Turkey, Brazil, Saudi Arabia, non-EU countries in Europe, and Africa. Russia is only a small exporter of gasoline, at under 100,000 b/d. Russia said it implemented the ban to make more supplies available to the domestic market to “help saturate the fuel market, which in turn will reduce prices for consumers,” according to the Cabinet of Ministers. Russia did not say how long the ban would remain in place.

Supply Cuts Amid Record Global Oil Demand and Low Inventories

The latest monthly reports from major forecasting organizations all depict strong global oil demand and much tighter market balances in the fourth quarter of 2023. The OPEC Secretariat’s September “Monthly Oil Market Report” signals an exceptionally tight balance, with cuts in OPEC+ production potentially leading to a massive drawdown in global oil stocks of over 3 mb/d in the fourth quarter in order to meet record oil demand levels. With global oil stocks already at exceptionally low levels, if OPEC’s forecast is realized, inventories during the fourth quarter could post the largest drawdown since at least 2007, according to Bloomberg estimates. The forecast for sharp stock drawdowns dovetails with Saudi Arabia’s apparent efforts to squeeze supplies and push inventories – the effective spare cushion for oil markets – to even lower levels.

In its September “Oil Market Report,” the IEA stated the “extension of output cuts by Saudi Arabia and Russia through year-end will lock in a substantial market deficit through 4Q23.” Its data shows a supply deficit for the second half of 2023 of 1.24 mb/d. The report also noted that global oil inventories were already at 12-month lows in August after plunging by a sharp 2.46 mb/d.

In sharp contrast to the OPEC report, the U.S. Energy Information Administration forecast a much smaller inventory drawdown in the fourth quarter, by a marginal 200,000 b/d. Despite the EIA’s more balanced outlook, it raised its forecast for spot Brent prices by $6.03/bbl to $92.68/bbl for the fourth quarter.

OPEC and the IEA have similar oil demand forecasts for the fourth quarter and full year. OPEC is projecting year-on-year growth of 2.17 mb/d for the fourth quarter and 2.44 mb/d for 2023, while the IEA sees slightly lower gains of 2.12 mb/d and 2.24 mb/d, respectively. The EIA is comparably the outlier, with demand growth at a higher 2.26 mb/d in the fourth quarter but lower for the full year at 1.81 mb/d.

Global oil supplies rose by 280,000 b/d to 101.5 mb/d in August, led higher by output increases largely from Canada and Iran, according to the IEA. The 23-member OPEC+ group increased production by 130,000 b/d to 42.75 mb/d month-on-month, equal to 42% of global supplies. Saudi Arabia produced 8.98 mb/d in August and is expected to hold output around 9 mb/d through the end of the year. Russian production was unchanged at 9.48 mb/d in August, the report noted.

Despite strong demand, global supply in the fourth quarter of 2023 is expected to be flat year on year. In addition to constrained OPEC+ output, supply from outside the alliance is forecast to decline by around 500,000 b/d between August and December as U.S. production growth stalls and biofuel output eases in line with seasonal trends, the IEA stated. Once considered a swing producer able to ramp up quickly, the United States’ shale production growth has been tempered as capital spending on projects has been reined in by demands that companies deliver better returns to shareholders. Equally, growth has been constricted by cost inflation, worker shortages, and supply chain disruptions, with shale growth forecast to slow from 740,000 b/d in 2023 to just 430,000 b/d in 2024, according to the IEA.

In the first half of 2023, global oil supplies exceeded demand, but the reverse trend will mark the last six months of the year, with global inventories needed to fill the gap. The projected stock draw varies wildly, with the EIA at the low end at just -200,000 b/d, the IEA in the middle at -1.1 mb/d, and OPEC at an exceptionally high -3.3 mb/d. Much may depend on Chinese demand, which is forecast to provide 75% of growth this year. If a weaker-than-expected economic recovery prevails, reducing demand growth, then tensions in the market balance could ease.

Oil Geopolitics Muted

The impact of higher prices on the global economy may yet spur diplomatic efforts to seek an increase in oil supplies to tamp down any inflationary effects. So far, however, there has been little public criticism by governments, including from the United States, where President Joseph R. Biden Jr. has been outspoken in the past about Saudi Arabia’s previous decisions to cut production.

Immediately after Saudi Arabia and Russia announced oil supply cuts would be maintained through the end of the year, during a White House press briefing National Security Advisor Jake Sullivan appeared to suggest that the United States is not concerned by the decision. “I would point out that what was announced today was a continuation of an existing policy, not a new set of cuts — just a continuation of those cuts for three months as opposed to for one month,” Sullivan said. “So, as far as I’m concerned, the most important thing that the President is focused on is just trying to do everything within his toolkit to be able to get lower prices for consumers at the gas pump in the United States,” he added.

When pressed over whether the United States has plans to engage with Saudi Arabia about the extended production cuts, Sullivan said nothing was currently planned. However, he left the door open, adding, “We have, obviously, regular engagement with the Saudis at multiple levels — with their energy minister, with their leadership — and that will continue. And we will make sure that they understand where we stand, and we will come to understand where they stand as well. And the thing that we ultimately stand for is a stable, effective supply of energy to the global markets so that we can in fact deliver relief to consumers at the pump.”

Saudi Arabia Holds the Lever to Ease Tight Oil Markets 

Amid record global oil demand, a severe supply deficit, and worrying low inventories, there remain limited options in the short term to relieve tight oil markets and temper escalating prices. Saudi Arabia, however, did qualify the extension of production cuts, saying that they would be reviewed on a monthly basis, according to the Saudi Press Agency, leaving the door open to rescind its decision if markets get too overheated. Equally, prices above $100/bbl may not be in the best interest of Saudi Arabia, according to Goldman Sachs, since these lofty levels could prompt U.S. shale producers to ramp up production to capture higher profits. At the same time, the bank added that higher prices could encourage more investment into clean energy in an effort to reduce dependence on expensive oil.

Perhaps a more compelling reason for an easing in Saudi Arabia’s hawkish policy is that the kingdom is now nearing $100/bbl plus from sales of its own crude. While the futures price for Brent is the international headline number, the world’s hundreds of different crude oil grades are priced using a multitude of criteria based on the specific quality characteristics of their oil to determine the market value. Saudi Arabia’s Arab Light crude is a gold standard for the market and has been fetching steep premiums to the international benchmark grades since mid-2022, bringing the price for its in-demand crude near $100/bbl in early September, according to an analysis by Bloomberg. The price for the country’s prized Arab Light crude rose to $98.47/bbl on September 13, according to the Bloomberg columnist’s calculations. With Brent last trading at just below $94/bbl on September 15, Saudi Light prices would be pegged just above $100/bbl.

Saudi Arabia sells its crude under long-term contracts based on a formula using regional benchmark crudes and factoring in a discount or premium differential, which is adjusted based on sales location, either to the Americas, Europe, or Asia. In assessing the differential to the benchmark crude, Saudi Aramco focuses on refining margins – the difference between the crude cost and the total value of the various products produced by the refinery, such as gasoline, diesel, jet fuel, and other products – in the various markets and adjusts its price formula based on the strength or weakness of these refining profit margins.

A combination of strong demand, constrained refining capacity, and the loss of sanctions-hit Russian crude supplies has pushed refining margins to record high levels since mid-2022. The cut in Russian supplies has made Saudi crudes more valuable, especially to U.S. and European refiners. In response, Saudi Arabia has increased its price premiums for its crude sales to all-time highs to capture a greater share of the profits that refiners have been enjoying. In Europe, Saudi crude is typically traded at a discount to Brent. However, since Russia’s invasion of Ukraine, with the exception of one month, the Saudi differential has been at a premium to Brent, reaching a peak $5.80/bbl in September.

Having reached the $100/bbl mark through price premium adjustments for its own crudes, Saudi Arabia may yet revisit its plans to extend its cuts through the fourth quarter if futures prices for international benchmark crudes Brent, WTI, and Dubai soar past that same threshold. Saudi Arabia has long prided itself as the central banker of the global oil market and, after prioritizing and achieving its own price ambitions, may yet factor in the damaging impact of triple-digit oil prices on the fragile global economic recovery in its decision making.