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Global Risks Forecast™

Only a flexible oil supply agreement can meet Saudi Arabia’s needs

Only a flexible oil supply agreement can meet Saudi Arabia’s needs

Key takeaways:

  • Our base case is that Saudi Arabia will cut production and seek a flexible OPEC agreement that shies away from specific allocations
  • OPEC meeting will be less about internal disagreement and more about how Saudi Arabia manages shifting relations with the US and Russia
  • Without a flexible agreement OPEC risks being quickly overtaken by events in 2019

Saudi Arabia faces a tough balancing act. Diversification efforts have not amounted to much, and to balanceits budget the kingdom needs much higher oil prices. But Saudi Arabia also needs to manage tense relations with Washington, which has responded negatively to talk of a cut. The Khashoggi case, which still hangs over the Saudi leadership, limits the country’s room for manoeuvre. Maintaining the unofficial oil pact with a Russia that is lukewarm about cuts is another hurdle that needs to be cleared.

Marrying these conflicting interests will be difficult, but not impossible. The wide spread in our consensus forecast for Saudi oil production next year underscores the high levels of uncertainty about the outcome of December’s OPEC meeting. Given Saudi Arabia’s need to balance a host of conflicting interests, our basecase scenario is a de-facto Saudi-led cut with Russian participation, but a flexible agreement that shies away from specific targets.

Judgment-based forecast: 2019 Saudi Oil Production relative to 2018

Will Saudi average daily oil production for 2019 be: Verisk Maplecroft consensus forecast*
A: >5% relative to 2018 9%
B: >0% to 5% relative to 2018 30%
C: -5% to 0% relative to 2018 49%
D: < -5% relative to 2018 11%

Source: Verisk Maplecroft. *See Focus box: Judgment-based forecasting at Verisk Maplecroft

Saudi-US relations in the balance

There is little doubt that the White House would respond negatively to a sharp OPEC cut. Still, Saudi Arabia is likely to calculate that with US midterm elections out of the way, Trump will pay less attention to OPEC and oil price movements more broadly. Clearly, the timing of OPEC’s allusions to a supply cut – the day after the US elections – was not a coincidence.

The Saudi authorities will be tempted to defy Washington. Undoubtedly, the Saudi leadership is very unhappy with the lack of warning from Washington that key importers of Iranian oil would be granted sanctions waivers. Trump’s decision to allow the flow of at least 1 million bpd from Iran until May is one of the key factors that point toward a cut in our forecast.

Iran oil and condensates exports

Source: Verisk Maplecroft, Platts, Tanker Trackers

However, Saudi Arabia cannot discount the US position entirely. Trump already has one eye on the presidential election in 2020 and preventing another oil price rally will be a key priority. More importantly, bipartisan scrutiny of the US-Saudi relationship is intensifying in Congress. A bipartisan congressional bill that would expose OPEC to US antitrust law failed to get off the ground during the Bush and Obama administrations. But given Trump’s repeated criticism of OPEC over the last year, the possibility of ‘NOPEC’ (No Oil Producing and Exporting Cartels) legislation gaining momentum is no longer remote.

As the chart below shows, the Khashoggi case has strained bilateral relations and risks causing lasting damage to the relationship. The US has already sanctioned 17 Saudi officials and the possibility of further action will weigh heavily on the minds of Saudi decision-makers as they prepare for OPEC talks in December.

Number of negative diplomatic exchanges between US & Saudi Arabia

Source: Verisk Maplecroft

Pushing for a sharp OPEC cut in the region of 1.5 million b/d or more would test relations with the Trump administration at a sensitive time in US-Saudi relations. This would risk putting wind in the sails of NOPEC supporters. A more cautious approach from Saudi Arabia is therefore probable. In practice, this will likely entail maintaining the flexibility allowed by the current OPEC agreement and avoiding explicit targets and individual country allocations.

Riyadh needs continued support from Moscow

For a supply cut agreement to be effective, Saudi Arabia needs Russia onboard. Combined, the two countries make up almost a quarter of global oil supply. If Saudi Arabia and OPEC want to counter rising US production and move the needle, they will need at least some cooperation from Russia.

So far, Russia has been much less enthusiastic about cutting supply than Saudi Arabia. Unlike Saudi Arabia, which needs an oil price of at least USD80 per barrel to balance its budget, Russia can balance its budget as long as oil stays above USD50 per barrel.

Saudi Arabia’s anger over Washington’s U-turn on Iran waivers nonetheless presents a strategic opportunity for Russia. Having stayed largely silent on the Khashoggi case, Moscow has an opportunity to strengthen relations with Riyadh further if it accommodates Saudi Arabia. An OPEC+ agreement led by Saudi Arabia and Russia that openly defies the US is unlikely; but we believe Riyadh has a good chance of securing the participation of Moscow in a flexible supply cut agreement.

OPEC risks another U-turn in 2019 without a flexible agreement

For Saudi Arabia, striking the right oil supply agreement in December will not simply be a case of getting the balance of supply and demand right. While politics always looms large over OPEC meetings, the upcoming gathering is shaping up to be one of the most politically complex to date. This time, it will be less about internal OPEC disagreement and more about how Saudi Arabia manages shifting relations with the US and Russia. 

Few doubt that Saudi production will come down over the coming months from the current all-time-high levels. However, the need to avoid a confrontation with the US over oil prices and maintain coordination with Russia will carry significant weight for Saudi Arabia.

Despite these restraining factors, a broader OPEC+ agreement to bring down production is within reach. An adaptable agreement that addresses immediate fears of over-supply without allocating specific country targets is a compromise that is likely to work for all parties. Another benefit of this approach is that it reduces the likelihood of another OPEC U-turn if the Trump administrations decide to not renew Iran waivers expiring in May. With around 1 million bpd of Iranian oil in the balance, a rigid OPEC agreement in the traditional mould risks quickly being overtaken by events in 2019.

Focus box

Judgment-based forecasting 

Our approach to forecasting rests on academic research into best practice for achieving forecast accuracy. Analysts start by establishing a baseline probability by defining relevant reference classes, a group of similar cases to the one being forecasted, and calculating (or estimating) the general frequency of the event within the reference classes. Once the baseline probability is established, the analysts consider the factors pertinent to the case at hand and adjust their baselines to reflect these distinctive features. Anchoring a forecast on the general occurrence of an event (the reference classes and their implied baselines) is a first step towards eliminating bias; our internal process, including reviewing, further supports the robustness of the analysis.

Our consensus forecast takes the average of a group of individual forecasts of the same question. Group forecasts benefit from the wisdom of our Maplecroft crowd and further protects against biases influencing the forecast.

We will return to update the forecasts over time and publish these updates alongside new Insights on the topic. Forecasts will be resolved at the end of a forecast period, or before if the event in question takes place within the forecast period. We will track our forecast accuracy over time.

By Torbjorn Soltvedt, Politics Principal Analyst, MENA

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