Oil production cuts refresh inflation
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Saudi Arabia and Russia have announced cuts to their exports of crude oil. In August, Russia will reduce its oil exports by 500,000 barrels per day (bpd) and Saudi Arabia will extend its cut (originally announced last month) of one million bpd; together the export cuts amount to 1.5% of global supply. This joint decision is an attempt to force the international benchmark price higher - Saudi Arabia wants the price closer to its breakeven $81/barrel. S&P Global estimated in January that Russia's breakeven crude price was much higher, $114/barrel. The Brent crude price - one international benchmark - traded today around $75/barrel. Russia faces a price cap on its oil (agreed by G7 countries) of $60/barrel, which came into force last December. This price cap policy allows companies based in countries that are in the coalition against Russia to continue providing maritime services for the transport of Russia oil only if that oil is sold at or below the price cap. Much Russian crude oil has been diverted away from its usual markets towards China and India and other countries that have not joined the sanctions. Its exports to India for example (suspected of being heavily discounted to around $55/barrel) in June rose to a record high of 1.5 million bpd. The fact that these two large crude oil producers - Russia accounts for some 13% of global output and Saudi Arabia 12% - are cooperating on cutbacks is significant for a number of reasons.
It draws a conclusive end to the crude oil struggle between the two of 2020, when the two countries engaged in a tit-for-tat battle for market dominance, in the midst of the Covid-19 pandemic. That spat, started by price discounts from Saudi Arabia, saw international prices fall to their lowest in 17 years and a collapse in leading stock markets around the world.
These production cuts were made known outside of a formal meeting of Opec+, the Organization of Petroleum Exporting Countries and its allies, which includes Russia. That such cuts have been announced outside a formal meeting indicates where the real power lies.
Saudi Arabia is not sanctioning Russia as a result of its invasion of Ukraine; indeed it has recently hosted a trade mission from Russia which included weapons manufacturers. It is also alleged that Saudi Arabia is buying Russian petroleum products at steep discounts.
Saudi Arabia has long been a 'client state' of the US. That it has now moved closer to Russia obviously weakens its ties to the US, which has knock-on effects for geo-political relations; it for example represent another chip away at the Dollar's international reserve status.
At the very least, that the two countries need higher crude oil prices and are willing to curb exports to bring that about means that inflation will continue to defy efforts by central banks to bring it down. If oil prices move up by 10% that lifts inflation expectations by 0.25%/year.
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