RONDELI BLOG

The Recent Decision of Saudi Arabia and its Impact on the Energy Market

2023 / 06 / 13

Davit Shatakishvili, Contributing Analyst, American University, Washington D.C

Saudi Arabia has decided to sharply reduce the supply of oil to the international energy market, which will fall by 1 million barrels per day from July this year. The country explained its decision by the need for stability and balance on the oil market. Back in October last year, the Organization of the Petroleum Exporting Countries (OPEC) and its partners (known as OPEC+) agreed to cut oil production by 2 million barrels a day. In April of this year, several OPEC+ member states announced a reduction in total daily production by 1.66 million barrels by the end of the year, of which Saudi Arabia's share is about half a million barrels.

On June 4, 2023, at a meeting held in Vienna, Austria, the OPEC+ member countries decided to leave the amount of oil production unchanged, and extended the above-mentioned two existing restrictions until the end of next year. It should be noted that Saudi Arabia, the largest exporter of crude oil, has unilaterally reduced oil supply, and, accordingly, from July, its production will decrease from 10 million barrels per day to 9 million barrels. It is interesting to consider what intentions may exist behind the decision, how much it will affect the oil market price, and what strategic goals are driven by the de facto leader of OPEC, Saudi Arabia.

What might lie behind this decision?

First of all, a decrease in oil supply leads to an increase in prices on the energy market, thus the OPEC member countries, including the Russian Federation, receive the greatest benefit. The previous two decisions to limit crude oil production naturally had an impact on market prices. For example, in October 2022, the price of Brent oil rose from 87 to 93 USD per barrel, and by the end of the year it had decreased to 80 USD. After the decision of April 2023, the price of the same type of oil increased from 83 to 87 USD per barrel, and in May it decreased again and fell below the 80 USD level. That is why some experts suppose that since the previous two restrictions did not have the desired results, Saudi Arabia’s latest decision serves the purpose of increasing oil market prices, after which the price of oil actually increased by about 2%. Currently, the price of a barrel of Brent oil stands at 77 USD, and the price of WTI at 73 USD.

It is a well-known fact that Saudi Arabia has long followed an economic policy that aligns with Russia’s interests, and its recent decision may be somewhat related to the reduced revenues of the Russian Federation, because the main source of funding for its aggressive war in Ukraine is the income it receives from energy resources. Although it is already difficult for Russia to trade in oil, after the G7 countries imposed a 60 US dollar upper limit on the sale price, together with ten packages of EU sanctions, it still manages to circumvent restrictions using so-called "dark fleet" tankers that manipulate location data or transfer oil from ship to ship to disguise its origin. However, it is clear that this effort is also associated with additional costs.

Although Saudi officials say they do not consider oil prices in reaching production decisions, the move could be perceived as an attempt to raise oil prices in response to global economic uncertainty and a possible decline in international demand. For reference, OPEC+ member states produce about 40% of the world’s crude oil, which means their policies have a huge impact on global market prices. In total, since October last year, the daily amount of oil production they have cut stands at 3.66 million barrels, which is about 3% of the global demand.

US President Joe Biden has demanded Saudi Arabia stop aggravating the geopolitical situation and return to a reasonable level of oil production. From late last year, the US began releasing millions of barrels of oil from its strategic oil reserves with the aim of reducing energy prices. At the same time, after Russia's invasion of Ukraine, European countries accused the OPEC alliance of manipulating oil prices, harming the global economy and pursuing Russian interests.

Saudi Arabia made a record 161 billion USD net profit from oil sales in 2022. This was largely due to the increase in the prices of energy resources in the international market and the sanctions imposed on Russia. According to the International Monetary Fund, Saudi Arabia needs to earn about 81 USD per barrel of oil to meet its already planned spending commitments. In recent years, it has embarked on ambitious infrastructure projects, including the 500 billion USD construction of a futuristic desert city called Neom.

While oil producers need revenues to supplement government budgets, they also need to consider the impact of high prices on oil-consuming countries. Too high an oil price can lead to inflation, reduce consumer purchasing power, and force central banks to raise interest rates. Accordingly, the higher refinancing rate has real potential to contain inflation, yet the reduction in the amount of money issued by commercial banks leads to a slowdown in economic growth, which has a chain effect.

Saudi Arabia's Strategic Interests

Against the backdrop of global economic challenges, with countries trying to achieve economic growth while trying to contain inflation, it is clear that for non-OPEC+ alliance member, oil-consuming states, all decisions that complicate work in this direction are unacceptable. However, behind the latest decision, we can also see wider interests, which are aimed at strengthening the regional hegemony of the Kingdom of Saudi Arabia.

Firstly, Saudi Arabia's decision to cut crude oil production shows a need to increase its budget revenues. Official Riyadh needs colossal sums to meet its ambitious economic agenda "Vision 2030", which envisages investing 3.2 trillion US dollars in the country. For example, last year, the country spent two times more money in the transport and construction sectors than the average of the last five years. Thus, its desire to increase global oil prices for its own financial gain puts the dynamics of global economic recovery at great risk.

Secondly, Saudi Arabia's decision, which incited a substantial reaction from Washington, strengthens the position about its inconsistent diplomatic policy. The United States-Saudi Arabia relationship is important to both sides for economic and security purposes. Proof of this can be seen in the March decision, which envisages the purchase of 121 American-made Boeing aircraft by Saudi Arabia, the total cost of which is 37 billion US dollars. Yet, at the same time, the country is strengthening diplomatic and economic ties with Russia, China and the neighboring Persian Gulf countries. As it appears, Saudi Arabia sees the United States as a supplier of military weapons and necessary trainings; China as the largest buyer of its energy resources; and Russia as a key ally in OPEC+.

For decades, Saudi Arabia positioned itself as a guarantor that ensured the stability of the global energy markets, which in turn meant the sustainable development of the world’s economy. However, its recent decisions show that its policy has shifted to prioritizing its own interests. At the same time, the reduction in oil production and the release of existing reserves raises the risk of oil shortages when demand exceeds supply. According to experts, the prices of oil and gasoline will increase in the current and next year, which will also be a hot political issue before the 2024 US presidential elections. Saudi Arabia will have the opportunity to reduce prices by increasing the supply of energy resources in the market, in return for receiving desired political and economic dividends from Washington.

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Thus, Saudi Arabia’s recent decision to reduce the supply of crude oil to the market increases both the risks of an increase in the oil price and of the creation of new problems for the world economy, which is already facing difficult challenges, especially when one of the main causes of global inflation is the increased prices of energy resources. With its recent decisions, Official Riyadh is strengthening its geopolitical position, and is pulling important levers of influence on various countries, making it an accountable regional power that the rest of the world will be taking a very cautious approach to in the long term.

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The Recent Decision of Saudi Arabia and its Impact on the Energy Market

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