Saudis Heed an Oil Warning From History

Sheikh Yamani said a high oil price would damage the kingdom's interests. Mohammed bin Salman seems to agree

After the failure of the Doha deal to freeze oil production, Saudi Arabia's output is now almost certain to rise in the coming months. It wants to regain market share in China and meet the summer peak in its own domestic demand without cutting exports.

As I wrote a couple of weeks ago, it's no surprise that Saudi Arabia refused to join the output freeze championed by Venezuela and Russia. It has little interest in seeing oil prices rise far enough to throw a lifeline to high-cost producers, who are beginning to buckle.

With the failure in Doha, the kingdom will probably lift production over the summer, helping prolong the oil glut. The use of crude for Saudi's domestic power generation usually rises more than 400,000 barrels per day between winter and summer, and we can expect oil production to follow a similar path this year to preserve the volume available to export.

Burning Issue

Saudi Arabia's direct crude oil burn

Source: JODI

5-year average (2011-2015)

Saudi Arabia has seen its share of the key China market being squeezed. While its sales to China have stagnated, those of arch-rival Russia have soared. At the end of 2013 Saudi Arabia was selling about twice as much oil to China as Russia was. Now they're vying for top spot with Russian sales exceeding Saudi Arabia's in several recent months.

Missing Out

Saudi Arabia's crude oil exports to China have stagnated, while Russia's have soared

Source: Bloomberg

Saudi Aramco, the state-owned producer, appears poised to adopt a new sales strategy to help compete. In a move described by Citibank analysts as 'dramatic', it made a rare one-off sale of crude to a small refiner in China. This seemingly minor change is a striking break from the Saudi policy of only selling oil under long contracts to established refiners with excellent credit ratings. Small Chinese refiners, known as "teapots", have driven a surge in the country's crude imports after being allowed to buy foreign supplies.

We can expect more sales from Aramco's storage tanks in Okinawa and Rotterdam as the kingdom steps up competition with Russia and a resurgent Iran for markets in Asia and Europe. Aramco might also store more oil at the Sidi Kerir terminal on Egypt's Mediterranean coast, letting it make similar spot sales to buyers in the region.

Saudi Arabia's determination to keep pumping more oil into global markets brings to mind its former oil minister Sheikh Yamani, who said back in 2000 that the Stone Age did not end for a lack of stones, and the oil age will not end for a lack of oil.

Those working for him at the time (including me), interpreted this as a warning to OPEC about the pursuit of high oil prices: namely, that it would just speed up the development of alternative technologies and drive away customers, leaving oil sitting beneath the ground without buyers.

Sixteen years later, the kingdom's leaders seem to have heeded his warning. Both Deputy Crown Prince Mohammed bin Salman and oil minister Ali al-Naimi have said they will no longer subsidize high-cost oil production by limiting supply. If there's oil to be left under the ground, they're determined it won't be Saudi Arabia's.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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