OPEC's oil production cut
American politicians like to imagine their exhortations have an effect on OPEC, and in particular on Saudi Arabia. This is mostly illusory. But is the organisation’s latest oil production cut, triggering angry exchanges between Riyadh and Washington, a political or an economic move? And is it a good or bad decision?
The US had lobbied hard for production increases following Joe Biden’s visit to Saudi Arabia in July. It got only a miniscule increase of 100,000 barrels per day (bpd) at the August meeting, rescinded in September. On October 5, at a meeting hurriedly shifted to in-person, OPEC+, the alliance grouping OPEC, Russia and several other leading non-OPEC states, agreed to cut its collective production target by 2 million bpd.
The actual production decrease will be less, probably around 900,000 bpd, since several members have been underproducing, and some others will not fully comply. And the group’s accord has been extended to the end of 2023, with bimonthly meetings replacing the previous monthly ones.
All the American opprobrium has fallen on Riyadh. The Biden administration feels the move is economically unnecessary, could have been delayed a month, benefits Russia, and comes despite constructive US suggestions such as refilling the Strategic Petroleum Reserve (SPR) if prices fall below $75 per barrel.
But, as OPEC rules require, the decision was unanimous, reached after a short meeting. Saudi Arabia is only one of thirteen countries in OPEC, albeit the de facto leader, with a further 11 in the OPEC+ grouping. Of these, only Iran, Venezuela and Russia are clearly anti-American, and several of the others are historically pro-Western. US National Security Council John Kirby said that “more than one” OPEC member disagreed with the decision and felt coerced. The UAE and Iraq, the two countries with most spare capacity besides Saudi Arabia, were suggested as two of the dissenting parties.
Saudi Arabia is a regional military player, and a global financial power and arms customer, but its geopolitical importance has always stemmed from its hydrocarbons. And given its giant and long-lived reserves, the fundamental logic of Saudi oil output strategy has been clear: attempt to maintain reasonably high but not excessive prices, so that the world economy and oil demand remain robust, and it does not generate too much competition from other producers or non-oil technologies.
Relations between Riyadh and Washington
Much commentary has ascribed Saudi Arabia’s attitude to its political disagreements with the US: concern over the Iran nuclear talks (albeit going nowhere for now), disquiet at lack of US concern for the Kingdom’s security (although it was then president Donald Trump who said he was in “no rush” to respond to the 2019 Abqaiq attacks), its desire to build on the growing relationship with Russia, and Joe Biden’s personal antipathy for Crown Prince Mohammed bin Salman.
Yet such rifts in relations are not new. Saudi decisions on capacity and output have both political and economic consequences. But its major oil policy decisions are nearly all explicable in terms of market logic; there is no need to assume Riyadh was seeking to harm or help the US or any other country.
The Kingdom took part in oil embargoes on the West in response to the Arab-Israeli wars in 1967 and, with much greater consequence, 1973, the second occasion leading Henry Kissinger to hint darkly about seizing Arab oil fields. Although the clearest use of the oil weapon, the cuts in production by Saudi Arabia and other Arab states also capitalised on a tightening market to deliver history’s greatest petro-windfall.
In 1986 came the example that inspired subsequent US administrations: the Saudi decision to flood the market, causing a price crash, that catalysed the collapse of the Soviet Union. But this was oil minister Ahmed Zaki Yamani’s response to the failed attempt to defend unsustainable price levels. Saudi Arabia, by acting as OPEC’s swing producer, had seen its own production drop to just 3.6 million barrels per day, barely enough to cover its domestic needs and barter and loan commitments.
And vice-president George H.W. Bush actually flew to Riyadh in April 1986 to ask King Fahd for lower production, to protect the US domestic oil industry. It’s unclear whether this had any effect either; Saudi Arabia did restore quotas by December 1986, but it had made its point and scared its OPEC peers into greater compliance. Though anti-Communist, Fahd was unlikely to aspire to be the kingpin who brought down the Soviet Union; nearby Iran, which had to agree to a ceasefire with Iraq in August 1988, was a more likely target. And neither Riyadh nor Washington realised how vulnerable the USSR had become.
The 1990-91 Gulf War was the high point of the strategic and oil partnership. In the following years, the 9/11 attacks, the 2003 invasion of Iraq, and failure to make progress on 2002’s Arab Peace Initiative, caused further diplomatic breakdowns.
In May 2008, as rampant Chinese demand was sending prices soaring towards their all-time record that July, Saudi Arabia quietly rebuffed US requests for more production, with oil minister Ali Al Naimi saying, “Supply and demand are in balance today.”
The creation of OPEC
The creation of OPEC+ in 2016 and the accession of Russia was a diplomatic and market coup. OPEC had sought Moscow’s cooperation in production cuts since at least 2001, unsuccessfully. Russia’s compliance was vital in enabling OPEC to take on US shale and boost oil prices after the 2014 crash.
But it meant bringing within the hallowed halls of Helferstorferstraße 17 a nuclear-armed great power, one for which energy is just one component of national might. Russia cannot quite match Saudi Arabia as an oil giant, but it outweighs all other OPEC states together in the other elements of national strength. Instead of attempting to break this axis in March-April 2020, the White House reinforced it.
In the early stages of the Covid pandemic, prices briefly went negative as consumption collapsed. Donald Trump reportedly told Saudi Arabia in April 2020 to cut production or US troops would be withdrawn from the Kingdom. He threatened publicly to impose tariffs on Russian and Saudi oil to protect the domestic petroleum industry, and said, “I thought [Mohammed bin Salman] and President Putin…were very reasonable. They knew they had a problem, and then this happened.”
Russia was, of course, very much in favour of this month’s production cut. Pre-war, it usually exceeded its quota. Now, it cannot reach its target, and will be even more exposed when European sanctions come into force on December 5. Tightening energy markets further ahead of winter is one of its few available gambits. The White House’s accusation is that “OPEC+ is aligning with Russia”.
Saudi Arabia’s reading of the oil market is not flawless. Even when its understanding is correct, and despite being the dominant voice in OPEC since 1979, it still has to contend with a shifting cast of fractious colleagues, with differing national interests, who do not always assess their options wisely.
Its errors are of two types. The first is putting too much production into a weak market, as in 1986, the infamous Jakarta meeting of November 1997, and the price wars of November 2014 and March 2020. But these instances may not be errors in the wider strategic view: in each case, Saudi Arabia was trying to punish one or more competitors to compel them to reduce their own output or to negotiate.
The second is more insidious: not increasing output enough in a tight market, as in mid-2008. Despite its long-term interests, Riyadh is not immune from enjoying temporarily high prices, even when they bring the dangers of demand destruction or a global economic slump.
The factors behind the cut
Oil prices have fallen steeply since June, with Brent crude dropping from $124 per barrel to $84 in late September, after which speculation on production cuts pushed them up a little. If prices had not dropped so much, OPEC+ would not have acted as it did. In that sense, this decision clearly has an economic basis.
But why now and why so much? In its latest oil market report, OPEC cut its forecast of demand for its crude in the fourth quarter this year by 440,000 bpd, and for next year slashed global demand estimates by 360,000 bpd. That is less than half the likely actual reduction as a result of the October 5 decision.
There is gloom over the Chinese economy and its continuing Covid lockdowns, a winter energy crisis in Europe, floundering UK fiscal policy, rising interest rates and high inflation worldwide. But the situation has not drastically deteriorated since the meetings in August and September. And a large cut risks exacerbating the slowdown.
The ban on nearly all Russian oil imports into the EU will come into effect in less than two months. The US SPR release would have finished this month, if the administration does not now extend it. Just in terms of economic logic, a cut was probably justified, but a smaller adjustment this month could have been followed by others.
If the US-European price cap on Russia works, higher oil prices as a result of the production cuts will not result in any extra revenues to Moscow, contradicting Mr Kirby’s suggestion that the OPEC+ cut would “increase Russian revenues and blunt the effectiveness of sanctions”.
But it is in the interest of OPEC+ that the price cap should not work. Sanctions have greatly reduced oil exports from Iran and Venezuela, and the potential and perennial “NOPEC” bill is likely to resurface in the US Congress. A White House unfriendly to Riyadh and seeking to keep down inflation might try to apply this new tool more widely.
In a way, it’s interesting that oil buyers have not tried to organise their own cartel before. “There are some who say we are trying to organize a consumers' cooperative…None of these statements is accurate,” said Kissinger in February 1974. The International Energy Agency (IEA) was indeed established that November, but it aimed to coordinate the industrialised countries’ energy policies, not to form a counter-OPEC monopsony.
The Biden administration has been dusting off all its options, and inventing others, to head off oil prices. In a rejoinder to the White House’s criticism, the Saudi foreign ministry stated that its government “clarified through its continuous consultation with the US Administration that all economic analyses indicate that postponing the OPEC+ decision for a month, according to what has been suggested, would have had negative economic consequences.”
A month’s delay would have meant the decision would not have had time to have an impact before the US mid-term elections on November 8. So after years of manipulating the market through sanctions, the SPR and now a price cap, whose motives this time are the most nakedly political?
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