Saudi Arabia: March Output Cuts Likely

Published on February 24, 2020

Saudi policy officials were said to be somewhat taken aback by the concern, if not gloominess, of G20 finance ministers and central bank governors over the risks for an extended global economic fallout of the COVID-19 virus when they met this weekend in Riyadh.

On the other hand, the G20 caution has helped to sweep aside the hesitation for OPEC+ output cuts that prevailed a few weeks ago at the Joint Ministerial Monitoring Committee when Russia resisted a Saudi-led push for an emergency OPEC+ meeting and early output cut to counter falling global crude demand.

*** We understand that OPEC+ is now moving very rapidly towards a collective cut in crude oil output by at least 400,000 barrels per day and as much as 600,000 bpd at its scheduled March 5-6 Ministerial meeting in Vienna. One safeguard being considered to cement consensus is for the March cuts to be reviewed at the scheduled  June meeting, in which the output cuts could be either increased or reversed, depending on the crude demand outlook. ***

*** The lion’s share of the output cuts will come from Saudi Arabia, Kuwait, and the United Arab Emirates. Crucially, the Saudi-led Gulf state cuts will be joined by Russia with a nominal 50,000 bpd and enough in token cuts by the other 22 member oil producing states to try and make the new output targets credible to the markets. Should an increase in the scale of cuts be needed in June, Saudi Arabia will undertake almost all of the additional cuts in output. ***

*** A key linchpin to an OPEC+ consensus  – and between Riyadh and Moscow in particular – is a vow by Beijing to increase imports of crude oil from both Russia and especially Saudi Arabia this year. We understand that in a phone call to Saudi King Salman bin Abdul Aziz on the evening of February 6, Chinese President Xi Jinping reassured the Saudi King that China’s crude oil imports from Saudi Arabia will not decrease but continue to increase this year. ***

That promise, however, is predicated on the assumption the Chinese economy rebounds to close to capacity by the second quarter of this year.

Riyadh-Moscow Alliance Still Solid

The failure to pin down an output cut in February at the JMMC was not so much due to Russia’s reluctance to cut, as their argument at the time that it was a bit premature to commit to cuts, which was met with considerable sympathy among the other JMMC members and even shared to some extent by Saudi officials.

Riyadh has in fact been chafing over the lagged cooperation of Russia to the December Vienna agreement to remove 1.7 million bpd for three months starting in January. Those frustrations made their way into media reports that the cornerstone OPEC+ alliance between Riyadh and Moscow was under strain and at risk of breaking.

Notwithstanding the abundant Saudi frustrations, however, we could find no evidence of an emerging rupture, and the alliance between the two energy powers appears as viable as ever, a point made to the press this weekend by Saudi Energy Minister Prince Abdul Aziz al Salman, the older brother to the Crown Prince Mohammed bin Salman.

Both countries are moving ahead with earlier agreements for mutual investments, with the Saudis committing their Public Investment Fund to investing in natural gas infrastructure in Russia while Rosneft among others is taking a stake in Sabic Steel, which was recently absorbed by Saudi Aramco.

Equally driving the Saudi reaffirmation of its commitment to working with Russia on the energy front is the overlay of regional diplomatic and strategic calculations: Russia is expanding its power broker role in the Mideast, slowly supplanting the United States as the key outside intermediary with influence over the key regional players, both Saudi Arabia and Iran, and with a hand on Iraq, Lebanon, and Yemen, as well as an outreach with Israel.

Chinese Crude Demand Promised to Still Rise

More critical, however, was the Saudi reassurance that any output cuts to bolster crude prices would not translate into a loss of market share to Russian oil companies, especially in China. Saudi Arabia is China’s top supplier of crude, followed by Russia.

As ordered by Premier Li Keqiang, officials at the National Development and Reform Commission sent messages to Saudi and Russian oil and energy authorities a week ago today that the impact of the novel coronavirus (COVID-19) epidemic on China’s economy and China’s crude oil demand will be mainly reflected in the first quarter.

China, they were told, has the confidence and capability to ensure its economy continues to grow steadily this year, and China’s crude oil imports this year will continue to grow on last year’s basis rather than decline or shrink.

The vow to increase imports of Saudi crude through this year was also made to the Saudi King in a phone call by President Xi on February 6. China imported 83.39 million tons, or an average of 600,000 bpd, of crude oil from Saudi Arabia in 2019, up 47% year-on-year.

This year’s increase will not be nearly as rapid, but that it was promised to be repeated if not modestly higher instead of falling is a critical factor in the Saudi willingness to press ahead with OPEC+ output cuts free from the fear of losing large-scale Chinese market share to the Russians.

Saudi Arabia has been expanding its downstream business, setting up several China-Saudi joint ventures in petroleum refining, storage and sales.

Two China-Saudi refining joint ventures, Hengli Petrochemical and Zhejiang Petrochemical, with a combined output capacity of 60 million tons per year, were granted oil import quotas totaling 24.3 million tons in 2019. Chinese officials believe that figure will keep growing, as Hengli’s first round quota for 2020 jumped 150% from 2019 to 10 million tons, and Zhejiang Petrochemical’s quota doubled to 8 million.

China claimed the COVID-19 epidemic will not affect China’s plans to import crude oil from Russia. China has plans to import at least 80 million tons of crude oil from Russia in 2020. China imported 77.94 million tons of Russian crude oil in 2019, up 9% from 71.49 million tons in 2018.

That said, although the NDRC and the National Energy Administration have not lowered China’s crude oil import growth target for 2020, their forecast for a resumption of full crude imports is premised on the sharp drop in crude demand being limited to the first quarter this year, by as much as 15-20 percent from the same period last year, or about 100 million tons in Q1 2020 from 121 million tons in Q1 2019 according to the GAC data.

What’s more, the Chinese projections for its annualized crude imports is premised on the epidemic being completely brought under control, with the economy fully returning to normal by the end of March, with China’s demand for crude oil subsequently rebounding strongly. That assumption may be severely challenged in the coming weeks.

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