Don’t Expect Saudi Arabia to Save the Day
Ben Cahill, Center for Strategic and International Studies, July 13, 2022
Energy is unmistakably on the agenda for President Joe Biden’s visit to Saudi Arabia. A splashy production announcement by Saudi Arabia seems unlikely, although surprises are possible. Even if the trip does not produce an immediate breakthrough, more constructive dialogue between Washington and Riyadh on energy matters is sorely needed.
For months, Biden has urged Saudi Arabia and the United Arab Emirates (UAE) to raise oil output. Presidents facing high gasoline prices have a limited toolkit, and in times of duress they tend to lean on Saudi Arabia and its Gulf allies to raise output. To date, Saudi Arabia’s response has frustrated the Biden administration, and this week’s trip acknowledges that the relationship needs some repair. But a few market realities need to be considered.
First, Saudi Arabia prefers to manage the market through the Organization of the Petroleum Exporting Countries and allied producers (OPEC+), not through unilateral moves. Saudi energy minister Abdulaziz bin Salman has consistently emphasized the importance of OPEC+ cohesion, including a central role for Russia. From the Saudi perspective, strong OPEC+ cooperation has helped the group navigate extreme price volatility in the past two years, and gradually brought the market back into balance. All member states contributed to the largest-ever production cut instituted in April 2020, and they largely stuck to their production targets despite the perennial temptation to cheat. Achieving this level of discipline was difficult but it has paid dividends. In April, Saudi oil exports generated nearly $1 billion in revenue every day
Second, Riyadh must manage spare capacity carefully. As OPEC+ has gradually restored more output over the past few years, available spare capacity has dwindled. Saudi Arabia’s production target for August per the OPEC+ agreement is just over 11 million barrels per day (b/d)—a level it has only attained for a few months in 2018 and 2020. Officially, the country’s “maximum sustainable capacity” is 12 million b/d. By the end of August, Saudi spare capacity will be down to about 1.2 million b/d (including some volumes from the Neutral Zone shared with Kuwait), and UAE spare capacity will be about 900,000 b/d. Iraq and others contribute a marginal amount. The International Energy Agency estimates that by the fourth quarter of this year, global spare capacity could drop to 2.6 million b/d. With such a small buffer, there is a risk that adding more output could spook the market and fail to cool prices.
There are always doubts about Saudi Arabia’s ability to reach and sustain peak output levels without damaging its reservoirs—but there are other reasons for the Saudis to be wary. Saudi Arabia has a unique role in the global oil market because it has developed and sustained spare capacity. If it maximizes output and burns through its spare capacity, there will be no room to cover a production shortfall in other countries due to war, accidents, or weather-related outages. But Saudi Arabia will also lose its strategic advantage—especially if it tries and fails to produce at full tilt. For these reasons, Saudi Aramco tends to be quite deliberate in its production pledges. The company is the middle of a production expansion to reach maximum sustainable output of 13 million b/d by 2027, but most volumes will come online in 2025 and beyond. For now, caution is the watchword.
Riyadh also has its own perspective on the current market. Saudi Arabia and the other major oil producers believe Western leaders have lost their way on energy policy. They think fossil fuels will be with us for much longer than Western leaders realize, and they fault the International Energy Agency and others for overestimating the pace of the energy transition and downplaying the need for continued investment in oil and gas. From the OPEC+ perspective, market tightness today is partly due to Western sanctions on Russia, and the challenges are too great for Saudi Arabia or the broader producers’ group to fix on their own. They also do not want to overreact by ramping up supply into a global market facing downside economic risks later this year. Still, Saudi Arabia feels the pressure from the United States and worries that high oil prices will hinder global economic growth and dent demand.
So, what will be the energy deliverables this week? The Biden administration seems to be lowering expectations, but National Security Adviser Jake Sullivan confirmed on Monday that the president will push for more supply. A surge in Saudi output seems unlikely, and it seems more probable that Saudi Arabia will make a general commitment to add supplies this fall if possible. Any increase is likely to be modest, although a positive supply signal could shift market sentiment.
An alternative scenario is a temporary surge of Saudi production beginning in September. The current OPEC+ production framework expires at the end of August, and it remains uncertain what happens next. Ideally, a new OPEC+ deal would feature higher reference production volumes for Saudi Arabia and the UAE, allowing them space to raise output, while lowering reference levels for countries that habitually fall short of their targets. That is a delicate task, as no country wants to accept a lower ceiling. The next OPEC+ meeting is on August 3, but it may be hard to work through the complexities of a new deal by then. It is possible that Saudi Arabia and the rest of the group will simply operate without a new agreement for some time, effectively producing at will and allowing Saudi Arabia and the UAE to ramp up output. There are risks to this free-range approach, but it could allow the Saudis to help meet an immediate U.S. demand, while testing the strength of the market.