The Fuse

Risk of Saudi Oil Policy Shift Could Rise in 2022

by Nick Cunningham | August 30, 2021

OPEC+ has spent the past year and a half keeping huge volumes of oil supply off of the market in an effort to mop up surplus and prop up prices. From their perspective, this arrangement has succeeded. In fact, prices have climbed to such a degree that the U.S. government pressed the cartel to increase production in recent weeks.

But the medium- and long-term strategy could be entirely different. Beyond the immediate oil market calculations related to the pandemic, the major producers of OPEC+ could see their incentives shift, potentially setting off a scramble to fight for market share as peak demand becomes more obvious and decline sets in.

A shift in oil policy

For now, OPEC+ is sticking with its strategy of keeping millions of barrels per day of oil production capacity idle. If anything, the Delta variant promises to keep the arrangement in place a little while longer.

OPEC+ still has plans to increase production incrementally over the next year or so, but as the effects of the pandemic wear off, the cohesion among OPEC+ could begin to fray.

The dispute with the UAE in July over the OPEC+ agreement and how much oil to add back onto the market underscored the tensions in the group’s strategy, strains that may become more pronounced. As the pandemic recedes, “cracks are likely to emerge within OPEC+ as producers will want to exit the agreement at different stages,” Torbjorn Soltvedt, a political risk analyst with Verisk Maplecroft, wrote in an analyst note.

Meanwhile, climate change concerns are rapidly moving to the front-burner, with policies aimed at cutting greenhouse gas emissions becoming more stringent.

Saudi officials have dismissed rapid decarbonization scenarios, with Saudi energy minister Prince Abdulaziz calling the International Energy Agency’s net-zero scenario “La La Land.”

Various OPEC+ officials have suggested that peak oil demand lies a decade or two off into the future, to be followed by a long plateau. But an anonymous OPEC official told Reuters that climate change policies are quickly moving that date forward, and the cartel may even revise its long-term demand forecasts lower in a forthcoming report.

“Oil demand may peak quite early, even in the mid-2020s or earlier,” an OPEC official told Reuters.

“The low-cost producers such as Saudi Arabia and the rest of the Gulf would work hard to increase their market share. The smaller and higher-cost international oil companies and countries will indeed suffer,” the official said.

Planning for decline

As peak demand approaches, the urge to fight for market share may take over.

“OPEC+ will face a major challenge in how to deal with shrinking demand but also increasing pressures to lower prices due to oversupply,” Chakib Khelil, a former Algerian oil minister and two-time OPEC president, told Reuters.

As one of the largest oil producers in the world, and with a very oil-dependent economy, Saudi Arabia would appear to be at great risk and highly vulnerable to the energy transition. But Saudi Aramco believes that its enormous reserves and low-cost production positions it well to still hold a commanding share of the market for a long period of time. Its oil is also relatively less carbon-intensive compared to other producers around the world, so carbon-pricing and other climate policy will hit other producers harder.

Last year, Saudi Aramco announced plans to increase oil production capacity from 12 to 13 million barrels per day (Mb/d), a strategy aimed at boosting spare capacity and taking a larger share of a shrinking oil market pie over the coming decades. It is expected to take until 2023 before that milestone is reached, but the move comes as publicly-traded western oil majors are slashing capex amid shareholder pressure to restraint spending and production growth.

“As production gets closer to full capacity, Saudi Arabia’s ability to influence OPEC and the oil market will weaken,” Soltvedt warned.

The firm also noted that the risk of an unpredictable shift in Saudi oil policy has increased in recent years as decision-making has been consolidated in Riyadh under the “de-facto leadership of Crown Prince Mohamad bin Salman.”

There are many disincentives to rushing back into a strategy of grabbing market share, not least of which is the hit to revenues from the expected fall in oil prices. “In parallel, falling reserves have made the initial pain of low oil prices associated with a market share-based strategy more difficult to bear,” Soltvedt wrote.

But he also said that the risk of abrupt strategy shift, where Saudi Arabia ramps up production to take market share, will be higher in 2022 as the OPEC+ agreement winds down.

U.S. shale drillers are modestly adding rigs back into the field, and stepping up spending ever-so-slightly, but the reckless spending and drilling practices of the past decade are mostly a thing of the past. Shareholder pressure, including on the oil majors, could keep the U.S. from a return to its 13-million-barrel-per-day peak. And stricter climate policy over time could whittle away at that even more, especially as demand-side policy erodes consumption.

As the oil industry gets hit from all sides, the state-owned low-cost producers could benefit, taking more market share. That is, until the energy transition comes for them as well.

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