Tensions are rising between Saudi Arabia and Russia over oil production and price. Saudi, the de facto leader of OPEC+, voluntarily reduced output in the first week of June 2023. According to sources, this was one of the most contentious production meetings in recent years, as slowing energy demand failed to convince the OPEC+ (Organization of Petroleum Exporting Countries and its Russian-led allies) that they should move their current official targets. OPEC+ accounts for approximately half of the world’s oil output, and a production cut was expected to help buoy prices which have declined from 2022 after $130 per barrel on a West Texas Intermediate basis, to just above $70 per barrel (see chart). The move by Saudi Arabia comes as tensions are rising between Russia and Saudi Arabia. Russia continues to pump huge volumes of cheaper crude oil into the market, undermining the Saudi effort to buoy oil prices.
What are Tensions Rising
The friction between Russia and Saudi Arabia was evident before the cartel met in Vienna for its OPEC+ production meeting. The goal of the meeting was to decide on oil production by members of OPEC+ for H2 2023, as concerns of a contraction in global economic growth were generating demand destruction. Ahead of the Vienna meeting, the Saudi Energy Minister warned oil speculators that a production cut was likely, and there would be financial pain for those who dared to be short oil futures. Clearly, Saudi Arabia would issue voluntary cuts allowing other cartel members to gain market share.
What is Shorting a Futures Contract
The warning by the Saudi Oil Minister was a jawboning technique to help buoy West Texas Intermediate and Brent crude oil to move higher. West Texas Intermediate is a North American benchmark for crude oil. It prices most crude oil in the United States and Canada. WTI is a light sweet crude oil. It contains between 0.24% and 0.34% sulfur, making it sweet, and has a low density, making it light. WTI is the underlying crude oil that is used by the New York Mercantile Exchange futures contract and is one of the more liquid futures contracts available to trade oil. WTI is generally traded in Cushing, Oklahoma, where the futures contract is delivered and stored. The Cushing, Oklahoma, location is a broad system of pipelines and storage facilities and consists of 35 different inbound and outbound pipelines and 16 storage terminals. The inbound and outbound pipeline system has a capacity of 6.5 million barrels of crude oil daily. WTI has a sulfur content below 0.5%, making it ideal for refining gasoline.
The oil ministers’ goal in warning speculators who are short oil futures contracts was to reduce the number of speculators participating in crude oil investing betting that the oil price will decline. Shorting a futures contract is a trading strategy involving selling a futures contract with the expectation that the underlying asset’s price will decrease. This strategy is used by traders to speculate on the direction of the market and to hedge against potential losses. The trader will enter into a contract to sell a futures contract at a specific price and then wait for the underlying asset’s price to decrease. If the price falls, the trader will buy back the contract at a lower price, resulting in a profit.
According to the commitment of traders report released by the Commodity Futures Trading Commission for May 30, 2023, just ahead of June 4, 2023, OPEC+ meeting, hedge funds, referred to as managed money, were short 98K futures and options.
The Commitment of Traders (COT) report is a weekly report published by the Commodity Futures Trading Commission (CFTC) that provides an overview of the open interest held by different types of traders in the futures markets. The report is divided into three categories: commercial traders, managed money, and non-reportable traders.
The commitment of traders report showed that about 98K contracts were short in the managed money category compared to 209K, which was long. The goal by the finance minister was likely to generate some upward pressure that would force some of the speculators who were short futures or options to cover their positions. Focusing on financial markets underscores the issues facing the Saudi prince and the oil affairs of the Saudi Kindom.
Why is Russia At Odds with Saudi Arabia
Russia and Saudi Arabia have been at odds over oil production for several reasons. First, the two countries have different strategies for managing their oil production. Russia is at war with Ukraine and needs revenue from oil at any price. Saudi Arabia wants to manage overall revenue, including optimal production at the highest price. Additionally, the two countries have different interests in the global oil market. Russia has also said that Ukraine is launching major attacks, which Ukraine reports is misinformation. The information provided by the Kremlin might be so they can sell more oil to countries like China and India, which have been Russia’s valued customers.
What Counties Cut Their Production
With the exception of Saudi Arabia, no other countries cut production. The outcome was not because Saudi Arabia did not try. Before the meeting, Saudi Oil Minister Abdulaziz spoke to some African delegates in Vienna and told them that their production quotas would contract. According to sources, the delegates left the meeting without a deal. Several African nations struggle to meet their projected levels as it’s been hard to combat Covid and the lack of investment in the oil infrastructure in those nations.
Saudi officials are pressured to keep the Brent oil prices above $81 per barrel, which will help keep the country’s budget stable.
What is Brent Crude Oil
Brent Crude is a type of crude oil used as a benchmark for pricing oil worldwide. It is a light, sweet crude oil sourced from the North Sea and used to set the price of most of the world’s traded crude oil supplies. Brent is traded on the Intercontinental Exchange and the Chicago Mercantile Exchange. Most of the liquidity is on the ICE exchange. Short positions in Brent oil, like WTI, are the focus of the Oil Minister. A short-cover or fewer short positions in futures and options will take some downward pressure off crude oil. Unfortunately, that could also reduce liquidity.
Do Speculators Provide Liquidity?
Speculators provide liquidity to the markets by buying and selling assets. They help create a more efficient market by offering buyers and sellers a way to quickly and easily trade assets. This activity helps to reduce the cost of trading and makes it easier for investors to find the best prices for their investments. If the Saudis force speculators who want to short oil futures contract out of the market, they might temporarily push the price higher but will create more volatility as liquidity contracts.
The Bottom Line
It’s clear there is a feud going on in the OPEC+ patch, and Saudi Arabia and Russia headline the rift. Each country has its internal issues that are driving its demands. They are no longer on the same page as Russia desperately needs money to fund its war effort and seems willing to sell crude to any buyer. Russia sells crude oil to China and India at ultra-low prices, weighing on benchmarks like WTI and Brent. There is no end to the war between Ukraine and Russia, and now that Ukraine is fighting back, Russia will desperately need money to pay for its war effort.
Conversely, Saudi Arabia bases its revenue production on specific prices and optimal production. If Brent oil prices drop below $81 per barrel, they can no longer fund their economic growth, which seems to be a focus of the Roay Crown Prince of Saudi Arabia. Saudi Arabia and Russia no longer have the same goal when it comes to OPEC+. Russia cannot afford to pull back production. Saudi Arabia is having difficulty finding countries to join its quest to drive up prices and risk the loss of market share. The ongoing feud is likely to generate volatility but not likely to drive up prices.
Saudi Arabia is also concerned about the demand for crude oil in the face of rising interest rates. Slower economic growth will likely drive down demand for crude oil products such as gasoline and diesel fuel. Until the central bank has reached its inflation goals, there will be headwinds for crude oil demand.
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