What a Saudi oil-supply freeze would really mean for markets

GRANT SMITH 2/24/2016

HOUSTON (Bloomberg) -- Saudi Arabia shot down rumors it might cut oil production, but reaffirmed its commitment to an output freeze that could restrict crude flows to market this summer. With the world’s biggest exporter already pumping near-record volumes, that may not matter.

Last week’s pledge to cap production at January levels along with Russia, Venezuela and Qatar—repeated Tuesday in Houston by Saudi Oil Minister Ali al-Naimi—could mean the Middle Eastern nation refrains from the typical output boost needed to feed the summer increase in domestic demand. Forgoing that surge would, in theory, deprive the market of exports equivalent to about a quarter of the current global crude surplus.

“Come summer, the production freeze will amount to a cut in Saudi crude exports,” said Olivier Jakob, managing director of consultant Petromatrix GmbH in Zug, Switzerland. “By holding supply at January levels and not increasing when their domestic requirement for power generation is at its peak, there will be about 500,000 bpd less Saudi crude making its way to global markets.”

Saudi Arabia has on average boosted output by about 360,000 bopd from January levels to the seasonal peak in June and July, according to figures going back to 2002 from the Riyadh-based Joint Organisations Data Initiative. Over the same period, the amount of crude the country burns to generate electricity typically rises by as much as 500,000 bpd as citizens turn up their air conditioning, the data show.

Seasonal Pattern

“The market is still assuming a big summer swing up” in Saudi production this year, said Amrita Sen, chief oil analyst at consultants Energy Aspects Ltd. in London. “The freeze is making people think Saudi exports may now have to be down over the summer.”

With Saudi Arabia’s production already at near-record levels, a dip in exports wouldn’t leave the market short.

The biggest member of the Organization of Petroleum Exporting Countries ramped output up last year to intensify pressure on U.S. shale producers and mark its territory before Iran’s return to world markets. It was pumping 10.2 MMbopd in January, according to data compiled by Bloomberg—a level that already exceeds the summer production peak in all but one of the past 10 years.

The exception was 2015, when peak summer output reached a record 10.6 MMbopd, 400,000 higher than last month’s level, according to data compiled by Bloomberg. The International Energy Agency projects the second-quarter supply surplus will be about 1.5 MMbopd.

This year, “the kingdom would not necessarily have to sacrifice crude exports to meet seasonal demand,” according to Sen. It has large amounts of oil in storage plus natural gas from the new Wasit project that could feed power generation, she said. “If alternatives can fill the gap in the summer, the dip in Saudi summer exports will not be that significant.”

Finally, as OPEC Secretary-General Abdalla El-Badri affirmed in Houston on Monday, the freeze agreement will initially last three to four months before the participants decide whether to take other steps—potentially expiring at exactly the time Saudi Arabia would typically open the taps. The accord is “the beginning of the process” and producing countries will gather again in March to discuss it, al-Naimi said Tuesday.

Oil sank after Naimi’s comments, during which he ruled out that the deal was a prelude to output cuts. Benchmark Brent crude traded 2.3% lower at $32.52/bbl as of 10:55 a.m. in London.

As far as the other participants in the freeze are concerned, the impact will be limited because they were already expected to have flat production this year, according to IEA Executive Director Fatih Birol.

The whole agreement could turn out to be an empty gesture, said Harry Tchilinguirian, head of commodity markets strategy at BNP Paribas SA.

“For Saudi Arabia to announce an output freeze is disingenuous when their production levels are already at the high watermark,” Tchilinguirian said.

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