Saudi Arabia and the OPEC Deal – 10/17/16

To make production cuts work, Saudi Arabia was always going to need to pick up the slack from its “partners” in and out of OPEC. The real question is how much of a burden is Saudi Arabia willing to take on for the sake of the deal.

It is possible for Saudi officials to reach the 32.5 million to 33 million-barrel range they agreed to with the rest of OPEC using only the usual seasonal reductions, but only in the unlikely event that other countries don’t increase output. Add to the equation surprisingly tenacious and quick-to-recover U.S. shale drillers and the deal could get very raw very quickly for the Saudis.

With OPEC pumping just over 33.5 million barrels a day in August, reducing volumes to the upper end of the range set in Algiers would involve a reduction of 500,000 barrels. But if Nigeria and Libya both meet expected additions to their output, they could add a million barrels a day. Making up for that cut could be a bigger sacrifice than Saudi Arabia is prepared to make, especially given its reluctance to give up market share and its own economic struggles.

Low oil prices have devastated the world’s largest oil exporter. Austerity measures aimed at reducing a budget deficit of 16% of GDP in 2015 are already hurting consumption as the government had raised the prices of fuel and utilities. Such reforms will have long-term benefits, but in the near term will be undoubtedly unpopular and difficult to implement.

Saudi officials are also considering canceling more than $20 billion of oil projects to reduce capital spending. If capital spending this year is cut by 71% as expected, then the economy which has long relied on oil projects to drive non-oil economic activity will slow if not contract. Growth will likely slow to 0.6 percent this year from 3.4 percent in 2015, according to HSBC Holdings Plc.

So far, Saudi Arabia has said it will make the deal work, but it remains to be seen how dedicated the nation will be if others aren’t playing along.

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