A looming oil supply glut may make Saudi regret choosing Trump over Opec

The kingdom chose Trump over Opec back in June. Now, the rest of the producer group may want payback

Opec and friends meet in Vienna later this week, and the backdrop isn’t pretty. Oil prices are their lowest in over a year, and there’s the prospect of a glut in 2019 if the group doesn’t make a new deal to cut production.

But agreement may be impossible. Saudi Arabia is adamant the burden must be shared. Others in the group argue that the kingdom’s output boost since June has created the problem and it is up to the kingdom to solve it by bearing the brunt of the cuts.

The swing producer is in a difficult position. From an economic perspective Saudi Arabia needs production to fall. From a political one it may not be able to afford it.

To most people it is inconceivable that Saudi dissident Jamal Khashoggi was murdered in the country’s consulate in Istanbul without the knowledge and approval of Crown Prince Mohammed Bin Salman. President Donald Trump is not one of them. With a degree of charity not accorded his domestic political rivals, he has refrained from calling for MBS, as the crown prince is known, to be locked up, asserting that the case against him has not been proved beyond doubt.

That puts the de facto Saudi leader in a weak position. At the moment, it is only the US president who is shielding him and his country from potential sanctions and an extension of the Sherman anti-trust act aimed at hobbling Opec. This is the same president that has pressed the group hard all year to lower oil prices. So it will be very difficult for oil minister Khalid al-Falih to lobby hard for a meaningful output cut in Vienna.

A cut is needed, though, to balance supply and demand in 2019 and prevent another build-up in oil stockpiles. Opec’s own forecast shows global inventories growing at a rate of around 1.4 million barrels a day next year if the group’s members keep producing as they did in October. True, the prospect that production in Iran and Venezuela will fall in the coming months will offset some of that stockbuild. But the cut required is now bigger than it needed to be after the Saudis responded to pressure from Trump for lower oil prices by pumping at record levels in November. 

Saudi Arabia and Russia want a new baseline for the next round of cuts, one that enshrines their recent output increases. That may prove impossible. 

The two countries have boosted their combined crude production by nearly 1.5 million barrels a day since May. Returning levels to the targets agreed in the current deal would wipe out the projected 2019 stockbuild. Countries that haven’t increased output in recent months don’t see why they should now cut further while allowing the Opec+ group’s two biggest producers a free pass.

But even rolling the existing deal forward could prove problematic. While several Opec nations have pledged their support for extending cuts, those assurances have come mostly from countries that don’t expect to make any real contributions themselves. Kuwait and the U.A.E., which have also raised output in recent months, may trim this, but Iraq will remain a problem. Further increases in Iraqi supply are likely in the coming months if a recent deal giving the central government access to the Kurdish export pipeline holds.

Bringing along the non-Opec partners for a third year of cuts may prove even more difficult, as I wrote here. Russia’s position remains unclear. President Vladimir Putin said last week that crude around $60 a barrel is “absolutely fine,” suggesting he faces little economic pressure to extend restraint. In the end it will be a political decision, based on his wider ambitions in the Middle East.

Kazakhstan’s output hit a new record in November and Mexico’s natural decline from aging fields, which it offered up as cuts last time, may be coming to an end.

The best that Opec and friends may be able to do when they meet is push the decision further down the road, to a meeting in early 2019, by which time they might hope that Trump will have decided that his constituents in Texas also need higher oil prices.

With no new agreement, the existing one would roll over, at least until they meet again. True, adhering to it would require Saudi Arabia, the UAE and Kuwait to give up all of their recent output increases and few others to make any real cuts from current levels.

On paper, that would be enough to rebalance supply and demand in 2019, but it would still leave MBS with the problem of making very obvious production cuts against the wishes of the US president. To convince the market it is serious about rebalancing supply and demand Saudi Arabia will need to announce the cuts and implement them in a transparent way. To avoid repercussions from the White House MBS needs to do exactly the opposite.

It’s a difficult situation, but having chosen Trump over its Opec partners by boosting its output in June, the kingdom isn’t likely to receive much sympathy in Vienna.

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