Saudi And Russia Announces Production Cut To Year-End, What Happens Now?

Since the Saudi voluntary cut announcement in June, we told readers that our base case is for Saudi to extend the production cut into year-end. One of the main arguments for this was logistical timing issues, but more importantly, Saudis need substantially lower global oil inventories to support much higher oil prices, especially in the face of concerns about global oil demand.

Now that the Saudis and Russians have announced their respective voluntary cuts will last into year-end (1 million b/d and 300k b/d, respectively), what should readers expect? 

But first, let me go through a key negative about this announcement.

Negatives

I believe it was a mistake to announce an extension for 3 months. Why? It was in Saudi's advantage to keep it at a monthly interval to surprise the market. While the consensus coming into this meeting all expected the Saudis to extend the cut into the end of October, I think the fact that the market doesn't "know" know is what gives Saudis the control element.

So by announcing a 3-month extension, the market participants can plan accordingly. In addition, with China possibly now looking at simulating domestic demand consumption, higher oil prices will be a headwind, so there's a good chance China will use SPR. This would imply lower physical buying and thus keep a headwind on oil prices.

This is why by keeping it a surprise, Saudis could keep draining inventory, which is the key point of this voluntary cut. Once inventories drain, oil prices will naturally rise.

Going forward, I fully expect lower Chinese crude buying. I think we will see a gradual decline in Chinese onshore crude inventories into year-end.

What to expect?

I believe this announcement further solidifies my point that the Saudis are dead serious about pushing oil prices higher. There's never been any precedence like this in history. Looking at August crude exports, Saudi averaged ~5.3 million b/d.