Saudi Arabia, Russia agree oil output cuts to push up prices

Saudi Arabia's Energy Minister Khalid al-Falih (L) and Russia's Energy Minister Alexander Novak attend a joint briefing in Beijing, 15 May 2017. [Reuters]

Saudi Arabia and Russia, the world’s two top oil producers, agreed today (15 May) to extend oil output cuts for a further nine months until March 2018 to rein in a global crude glut, pushing up prices.

The timing of the announcement ahead of OPEC’s next official meeting on 25 May and the statement’s strong wording surprised markets, and the move is expected to go a long way to ensure that other OPEC members and producers who participated in the initial round of cuts fall into line.

In a joint statement that followed an earlier meeting, Saudi energy minister Khalid al-Falih and his Russian counterpart Alexander Novak said they had agreed to prolong an existing deal until March next year.

The ministers pledged “to do whatever it takes” to reduce global inventories to their five-year average and expressed optimism they will secure support from producers beyond those in the current deal, the statement said.

“There has been a marked reduction to the inventories, but we’re not where we want to be in reaching the five-year average,” Falih told a briefing in Beijing alongside Novak.

“We’ve come to the conclusion that the agreement needs to be extended.”

Saudi, the defacto leader of OPEC, and Russia, the world’s biggest producer, together control a fifth of global supplies, but have been spurred into action as crude futures have languished around $50 per barrel.

Under the current agreement that started on 1 January, the Organisation of the Petroleum Exporting Countries (OPEC), and other producers including Russia pledged to cut output by almost 1.8 million barrels per day (bpd) during the first half of the year.

While it was broadly expected that OPEC and Russia would agree to extend the cut, the timing and wording of the statement sent crude prices up more than 1.5% in Asian trading.

“I think OPEC and Russia recognise that in order to get the market back on their side they will need ‘shock and awe’ tactics where they need to go above and beyond a simple extension of the deal,” said Virendra Chauhan, Singapore-based analyst at Energy Aspects.

“The market will also be looking at export cuts and not just production cuts, which is what is required to rebalance the market.”

Russia’s top producer Rosneft helped prepare the deal and is ready to comply with the extension, according to Russian media.

US shale, the unknown

If producers maintain their cuts at the current pace, it could push the market into a small deficit by the fourth quarter, said Edward Bell, director for commodity research at Emirates NBD in Dubai.

But one major unknown will be the response of low-cost US shale producers, which could undermine the unified effort to prop up the market.

The United States did not participate in the original agreement to cut supplies and producers there have ramped up output this year, buoyed by the recovery in prices from multi-year lows hit in January 2016.

US drilling activity last week rose to its highest in two years, while US production has jumped more than 10% since its mid-2016 trough.

A jump in US exports to Asia, the world’s biggest and fastest growing market and the last region in which OPEC supplies dominate, is a particular worry for the producer club.

“Russia and Saudi Arabia may be trying to coordinate a push to keep access to their most important market (China) in their favour and encourage Chinese importers to displace alternative cargoes,” said Bell.

An OPEC source familiar with the market situation told Reuters earlier on Monday that oil inventories in floating storage have declined by one-third since the start of the year.