Why has Saudi Arabia cut oil production?

The news that Saudi Arabia would cut oil production by 1 million buckets per day (m b/d) from 9.1 million came as a welcome surprise to many, none more so than Russian energy minister Alexander Novak. The shock announcement came at an OPEC+ (Organisation of Petroleum Exporting Countries) convention in early January 2021, and we are only now beginning to see its impact on the future market. 

This move has helped push Brent crude oil - the international standard for oil futures – past $60 for the first time since January 2020. What is most confusing about this manoeuvre, is that the country with the most to gain, is Russia, Saudi Arabia’s greatest oil rival. 

Their relationship was heavily strained in 2020, when they engaged in a furious oil-war, sending prices plummeting, notably with West Texas Intermediate futures going negative for the first time in history.

Since then relations have improved, with Novak supposedly being the only foreign diplomat to be aware of the Saudi production cut before it’s announcement at the conference in Riyadh.

What is most peculiar about this is that it appears completely unprompted, and they’ve made no call for other countries to follow suit.

Typically it would take months of debate at OPEC+ conferences to trigger a minor cut from many members, so a voluntary cut from a single major member is almost unprecedented.

So the pertinent question is this: What do Saudi Arabia hope to achieve from this? It is clear now that it has prompted a rise in oil prices, but does this cut represent a financial olive branch being extended to Russia and others?

There is some reason to accept this argument, with Saudi leading other Arab countries in restoring connections with Qatar, lifting the embargos it imposed in 2017. With the Middle East increasingly becoming a part of the developed world, perhaps Saudi is trying to settle its more volatile relations.

Saudi may also have concerns about further COVID lockdowns, and be preemptively decreasing production, to account for lower transport and industrial demand.

On the other hand, the financial perspective is – however unintuitively – more compelling. While it is certain that they are sacrificing market share, this may be softened by increased profits, as early as the end of Q1 2021. 

While Saudi are cutting production by 1 m b/d, Russia and Kazakhstan are increasing production by 75,000 b/d in February and March, with most of the other OPEC+ members keeping production steady.

This overall cut is one of the main forces behind the surge in prices. Other factors include the estimated $1.9Tn stimulus package from Joe Biden, low US shale production and broadly increasing commodity prices. 

Another factor in Saudi’s favour is the lower production cost. The country can expect to save $165 million over the course of the two months. They will also only be cutting 860,000 b/d of exported oil.

Factoring all this in, Saudi will turn a profit if oil prices stay above $58.2 through February and March, which they are certainly on track to do at the moment. 

Even though the financial outlook is positive, it is still unclear why Saudi has made such a cut, given the massive decrease in market share. One theory is that this is a production “arms test” of sorts. Saudi has notably larger storage capability than Russia, so this may be a demonstration of their impact on the market.

While it remains unclear what Saudi Arabia’s long term strategy is, the world can breathe a sigh of relief for now, as relations between Saudi Arabia, Russia, and the rest of OPEC+ are on the up and up. Let’s just hope this is, in the words of Saudi Crown Prince Mohammed bin Salman, a “sign of goodwill”.