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OPEC decided on December 5 to kick the can down the road yet again, postponing the timeframe for putting additional barrels back into the market until April 2025 and slowing the pace of the notional tapering so that the cuts will not unwind until the end of 2026. This avoids immediate financial pain for producers but does not offer a way out of the dilemma of producing well below capacity while the competing supply continues to grow. In fact, it is becoming increasingly clear that Saudi Arabia will eventually have to retake market share despite lower prices, and it might have reasons to do so more abruptly than the OPEC+ plan suggests.
Producing at around 9 million barrels per day (bpd) with nearly 3 million bpd of spare capacity is clearly not the long-term revenue maximizing path for Riyadh if competing production is just going to continue to take away market share, even though it is probably in the short-term. That is true even when one looks at it in terms of the net present value of the future stream of revenue, discounting the long-term future accordingly. However, this would be a major climbdown for Crown Prince Mohammed bin Salman. Shifting the kingdom toward a more “price hawkish” policy is one of his signature initiatives. Hence, the repeated delays from OPEC+, in which it wields disproportionate influence, in moving to retake market share.
The long-term view, though, will probably prevail eventually. Saudi Arabia can indeed cover its current budget deficits via borrowing, but long-term financial projections assuming production at current levels look a lot worse than long-term projections at higher levels. This is because a drop in prices due to excess supply would eventually revert to a similar equilibrium price based on the production cost of the marginal barrel plus the cost of providing an adequate return on capital for those higher-cost barrels, mainly deepwater and shale. Even if demand does not surge in the next few months prior to April, it will not make sense to leave the current cuts in place for anyone with the ability to manage their finances around a short-term price drop.
Once the unwinding begins, it may be hard to manage it. The UAE agreed to delay the beginning of its quota increases relative to its current position until April. However, it will still have 1.3 million bpd of spare capacity after that, which is well above usual historical levels. Given their very strong financial position and ability to manage for the long term, they will be less inclined than Riyadh to pause an unwinding of cuts due to a price drop. That logic, in turn, is going to help pull the Saudis toward staying the course. Significant “cheating” by Iraq and Kazakhstan is also going to be even harder to contain in an environment where the Saudis themselves are putting more on the market. The leverage the Saudis have is their ability to accelerate the unwinding if they choose, and it is possible that they could be forced to do so if the compliance of others weakens during the unwinding process.
Even a controlled unwinding will likely have to see enough of a slump in prices to put a significant dent into U.S. shale drilling activity, which could be achieved with a dip into the lower $60s. A process where coordination breaks down, however, could see prices move even lower for a year or so to kill off supply. That would be a major financial blow to producers with short-term financial concerns—Russia in particular—but the logic outlined above is going to pull Riyadh toward a “Saudi First” imperative, similar to when it abandoned the swing producer role in 1985, though with much less market share to retake which would yield a much shorter period of adjustment.
It also would be less severe than what we saw in 2020 during the COVID-19 pandemic and would not reach the threshold at which President Trump would press them to reverse course. In fact, the financial pain this would inflict on Russia might be just what Washington needs as it tries to bring the war in Ukraine to a close via negotiation with Moscow.
