Saudi Arabia announced January 5 that it would cut its production unilaterally by 1 million barrels per day in February and March, a generous gift to a market still reeling from the shock of the 2020 downturn. The pledge took the market by surprise, and within days, the price of Brent crude oil futures, the global benchmark, rose above $55 per barrel, its highest level since February 2020, just before the coronavirus pandemic sparked a global economic slowdown and drove down energy demand.

The move amounts to shock treatment administered to an oil market that has yet to see the impact on demand of the latest round of lockdowns as a more infectious strain of the virus has made its appearance. Given the haze of unpredictability that has emerged as a result, the OPEC kingpin wants to keep the oil market on its toes. When the ministers from the alliance of OPEC and non-OPEC producers, or OPEC+, met in December 2020, they agreed to ease some of the output restrictions in place since April, when OPEC+ reached a historic production cut agreement of around 10 mb/d to try to restore market balance and reverse the damage caused by a bruising price war between Saudi Arabia and Russia in March. The original intention was to ease the restrictions gradually in anticipation of a demand recovery and hopes that vaccines would be rolled out and allow for a return to some semblance of normality. But the new variant of the coronavirus, new lockdowns in several parts of the world, and the slower-than-expected rollout of the vaccine cast doubt on the timing of a recovery that would sustain higher production.

Such concerns led to a cautious decision in December to drip feed the market by increasing production by only 500,000 b/d as of January 2021, rather than the 1.9 mb/d that was originally intended, with further adjustments of no more than 500,000 b/d beyond that to be determined at monthly meetings. The small addition meant the total cut for January would be eased to 7.2 mb/d from 7.7 mb/d, on paper at least, since some producers that did not adhere fully to their allocations will have to make steeper cuts to compensate by April.

Russia, which has been wary of ceding market share to U.S. shale producers, in December insisted on a further production increase in February and would not agree with the OPEC+ majority to freeze production at the January level. Russian Deputy Prime Minister Alexander Novak, who has worked closely with Saudi Minister of Energy Prince Abdulaziz bin Salman, managed to extract a small concession. As the OPEC+ negotiations dragged into a second day, an agreement was reached to allow Russia and Kazakhstan a small increase of 75,000 b/d shared between them over two months, until the end of March. Moscow had argued that Russia needed to boost its oil production because of domestic requirements during the winter months. However, the volume is too small to address this, so the Russians were instead likely wanting to make a point that they will not easily cede market share and give rival producers an advantage. At the same time, the increase is not large enough to upset market balance, though it seems to have been a small price to pay to preserve cohesion of a disparate group of producers with specific domestic budgetary needs.

Announcing the decision to voluntarily slash Saudi production, Prince Abdulaziz called it a gift to the market and a message that Saudi Arabia was the “guardian” of the oil industry. Speaking to Bloomberg television on January 6, the Saudi minister said the decision was not an about-face and was purely a commercial decision taking into account market conditions and stock levels as well as the difficulties faced by some producers in the alliance. “We didn’t even consult with anybody. We felt that our partners in OPEC, for all sorts of reasons, underwent a very hard and rough experience, so has the entire industry. And asking them for an additional cut or restrictions is going to be too excruciating for all of them. So, we opted to take that option … we knew for certain that we could do it.” Prince Abdulaziz also explained that oil inventories were still above the 2015-19 average that has been adopted as an indicator of supply and demand balances, and current levels were still “nowhere near the average.”

Asked to comment on the fact that Saudi oil exports to the United States the previous year had fallen to zero for the first time since 1995, the Saudi minister said marketing decisions were taken by Saudi Aramco without government interference, and this was possibly due to better netback values of alternative crudes when converted to refined products. U.S. oil production, he said, had also improved in December, which meant lower import requirements. The latest data from the U.S. Energy Information Administration showed that U.S. oil output rose to 11.2 mb/d in November 2020 from 10.9 mb/d in September. Despite this uptick in production,  the EIA continues to project a slight decline in U.S. oil production, to 11.1 mb/d in 2021.

Some analysts saw the Saudi move as a gift not only to Russia and the other OPEC+ producers but to U.S. shale oil producers, which took a bit hit in 2020 as their already thin margins were squeezed further due to their relatively higher production costs. Yet the fundamentals justify the Saudi decision to restore its role as swing producer and, given the size of its production capacity, it is a significant concession. Under its self-assigned quota of 8.125 mb/d, the kingdom would be sitting on around 4.4 mb/d of spare capacity. In a weak market, additional spare capacity of that volume puts a floor under prices as it eases fears of a supply shortage should demand recover more strongly, though this now appears unlikely.

OPEC, in its December Monthly Oil Market report, forecast a demand recovery in 2021 but remaining below the pre-coronavirus level. OPEC expects total oil demand to rise from 89.99 mb/d in 2020 to 95.89 mb/d in 2021, a slightly lower projection than the previous month. The numbers are still below 2019 demand of around 100 mb/d.

OPEC Q1 Production To Remain Stable Despite Saudi Arabia’s Deep Cuts (in mb/d)

The current uncertainty may force another downward revision, at least for the first half of the year. In his opening remarks to the January OPEC+ conference, Prince Abdulaziz said global demand was still short of where it had been at the start of 2020 and demand for transport fuels, particularly aviation fuel, was “particularly fragile.” He described 2020 as a “rollercoaster ride,” and the Saudi decision to ride out a challenging first quarter of 2021 on its own is perhaps an indication that producers have some way to go before reaching the finish line, a point at which oil prices stabilize at higher levels and inventories are drawn down.