Oil Prices Retreat Slightly on News of Imminent Saudi Arabian Oil Output Boost

NYMEX crude July futures closed down somewhat on Friday (13 June) following news from Saudi Arabia that an oil production boost might soon be on the way. After having reached an intraday high of US$137.08/b, the benchmark went on to close at US$134.86/b—down US$1.88 on the day. Prices have this morning continued their light downward trend, with the front-month contract trading at US$134.20/b at the time of writing. Meanwhile, ICE Brent July futures in London also fell on Friday, closing at US$134.25/b—down US$1.84 on the day.

Oil prices began their retreat late on Friday after reports began to emerge that Saudi Arabia might increase its production by as much as 500,000 b/d in July, taking aggregate output in the world's largest oil producer to over 10 million b/d. These reports have since proved to be overly optimistic, though Saudi Arabia has clarified that it will be increasing production by around 200,000 b/d, in addition to the 300,000-b/d hike it recently announced for June. The country will increase production by just over 2% from current levels of 9.45 million b/d—a level of output not seen since 1981.

The kingdom's move has been widely interpreted as an attempt to deflect increasing international pressure over a spiralling crude price and increased volatility, hurting the economy in developed consumer markets and leading to protests and potential unrest in some developing countries that are increasingly unable to afford their fuel-subsidy regimes. While OPEC and its main producer, Saudi Arabia, have been singled out as the main culprits for the rising prices, especially by developed consumer nations in North America and Europe, OPEC has continued to maintain that markets remain well supplied. Among the reasons for price rises have been low Western investment in refinery infrastructure and a large-scale migration of global capital—amid a weak U.S. dollar—to commodities. Global crude inventory build-ups in the last months have at least lent credence to the supply side of the argument.

To deflect the blame and regain the initiative, Saudi Arabia last week called representatives for OPEC producer nations, consumer markets, executives from the oil majors, and leaders of some of the world's main private financial companies, to a high-level meeting in its financial capital, Jeddah, on 22 June. By increasing its output Saudi Arabia has not so much merely given in to international political pressure, as taken the first step, placing the onus on all other parties in the conference to do their part to calm the crude markets and facilitate continued investment in the world's oil and gas sector. Indeed, Saudi Arabia has not changed its continued assumption that the world crude markets are adequately supplied at the moment, rather portraying the production increase as an increment given to placate market fears and a demonstration of its ability to raise crude production further, alleviating perceived market tightness.

Outlook and Implications

After several years of very high crude export windfalls, Saudi Arabia seems to have felt ready to take the risk of over-supplying the crude market in the short run to facilitate its political goals, counting on a continued sense of quota discipline within OPEC should there be a significant dent in demand going forward. In this sense, the Saudi strategy has reverted to the more traditional longer-term outlook of fearing crude prices that could threaten demand destruction. The position essentially seeks to counterbalance economic downturns in its markets by making sure that supply is within reach even when its clients' purchasing-power declines.

The Saudi move to boost output has received a nod of approval from the United States, with a spokesperson for President George W. Bush being quoted by Reuters as saying "we would welcome any and all increases in oil production, including from Saudi Arabia". There is little doubt that the increased volumes from Saudi Arabia will ease the supply balance for the rest of the second quarter, going into the third quarter of 2008, though the question of how long this extra output is maintained is important. For the moment, markets are reacting cautiously to the news, knowing that to the extent that Saudi Arabia can increase production at will, it can also reverse this position just as quickly.

Global Insight continues to anticipate that oil prices will experience a mild correction during the second half of this year, which could increase internal pressure within Saudi Arabia, and OPEC more generally, to roll back production quotas commensurately. For the immediate term at least, the country will be looking to reduce some of the price volatility seen in oil markets of late that has culminated most recently with the unprecedented single-day jump of US$10.75 to a new intraday oil price record of US$139.12/b. In the United States, the world's largest oil consumer, these high oil prices have already combined with a weakening economy, low interest rates, and a weak U.S. dollar to reduce demand growth for crude and products and the latest information from the Energy Information Administration (EIA) suggests that U.S. refiners have responded to this by importing and refining less crude than expected for this time of the year. Oil-market volatility is expected to continue this week as further details on the Saudi position trickle out, but all eyes will now be on the 22 June meeting. Whatever the case, the Saudi move means that the Jeddah meeting will now begin with the onus placed squarely on consumer nations to yield for it to be productive. Unfortunately, given the vague agenda, it is still hard to see what additional suggestions and concrete outcomes could result.

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