Saudi Arabia Can Control Oil Supply, But Demand May Be Its Achilles’ Heel

(Reuters) — Saudi Arabia has signaled it is willing to enter a painful price war to assert dominance over other oil producers, but worsening global economic conditions mean the kingdom's standard playbook might be less effective this time around.

Saudi Energy Minister Prince Abdulaziz bin Salman in recent weeks has appeared to threaten an all-out price war to restrain recalcitrant OPEC+ members that have failed to comply with the alliance’s production quotas.

The strategy appeared to shift into a higher gear over the weekend. On Saturday, six key members of the Organization of the Petroleum Exporting Countries plus Russia and Kazakhstan agreed to rapidly unwind production cuts for a second consecutive month.

The decision to add 411,000 barrels per day of oil in June means that between April and the end of next month, OPEC+ will have added 960,000 bpd into the market, which is already well supplied.

OPEC+ sources have told Reuters that the group could further accelerate the production hikes and bring back to the market as much as 2.2 million barrels per day by November.

The OPEC+ moves shocked the market, pulling benchmark Brent crude prices below $60 a barrel on Monday, a threshold beneath which many producers will struggle to make money.

Even more ominous, oil future prices from October onwards are now in a contango structure, whereby crude prices for future delivery are trading at higher prices than contracts for closer delivery, indicating market expectations for long-term oversupply.

This will likely make oil producers think twice before investing in new production, and could lead many short-cycle U.S. shale producers to cut activity.

Same Old Story?

On its face, this looks like a familiar pattern. In 2014, Saudi Arabia launched a market share war to strangle soaring U.S. shale production. In 2020, it clashed with Russia at the peak of the coronavirus pandemic.

And today the kingdom is allowing more supply to flood markets at a time when it is upset with Kazakhstan, Iraq and possibly the United Arab Emirates for repeatedly exceeding production quotas under an OPEC+ supply agreement.

Does that mean the outcome will be the same today? Not necessarily.

The 2014-16 price war largely achieved Riyadh’s goals, reducing global supplies and increasing Saudi Arabia’s control of the market, as did the 2020 spat, which resulted in Saudi Arabia and Russia both curbing production and agreeing to coordinate activity going forward.

But this time Saudi Arabia faces a major problem. Its supply-boosting strategy may fail to produce a proper demand response, an essential component of any successful price war.

Historically, lower oil prices have generated higher demand, particularly in price-sensitive markets in Asia and the United States. Global demand rose by nearly 2 million bpd in 2015, above last decade’s average of 1.3 million bpd, according to data from the International Energy Agency.

But the 20% drop in oil prices since the start of this year has arguably been driven mostly by concerns over the global demand outlook due to U.S. President Donald Trump's trade war, particularly the spat with China.

Slowing freight activity between the world’s two largest economies and warnings from big-name multinationals suggest that tensions could persist for months, if not years.

So, there is no guarantee that a sharp drop in oil prices will spark a meaningful surge in demand.

Instead, producers could potentially end up fighting for share of a shrinking oil demand pie. This could produce further price volatility and threaten to undermine Riyadh’s longstanding control of the market.

Perhaps a better parallel can be drawn from late 1997, when OPEC raised members’ production quotas sharply only months before the Asian financial crisis hit, leading to a 50% drop in oil prices over the following 12 months as demand crumbled.

‘Volatility Buster’

Saudi officials have been telling market participants behind closed doors that the kingdom is willing and able to withstand a price downturn.

This is partly thanks to the country’s ability to access debt. Saudi Arabia's Public Investment Fund (PIF) has raised $11 billion in sukuk, or Islamic bonds, so far this year and is looking to raise up to an additional $2 billion in the coming weeks, according to Reuters.

But Riyadh would likely have to make uncomfortable sacrifices to withstand a sustained drop in prices.

Even though its oil production costs are among the lowest in the world, it also requires a crude price of over $90 a barrel to balance its national budget, according to the International Monetary Fund’s assessment of the 2025 budget.

And protracted market weakness could make OPEC+ members restless. That risks blowing up an alliance that has become a central tenet of Saudi Arabia’s foreign policy in recent years.

So Saudi Arabia can start a price war, but with Washington now the biggest factor in the demand equation, Riyadh may struggle to win it.

The opinions expressed here are those of the author, a columnist for Reuters.

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