Saudi oil production is up, but here’s why it has nothing to do with freeze talks

Saudi Arabia’s oil production hit a record in July, according to published statistics, and is likely to hit another in August, according to industry sources.

Some analysts have interpreted the increases as an aggressive demonstration of the kingdom’s ability to ramp up output ahead of an informal meeting of oil ministers in Algeria next month.

In this view, Saudi Arabia is increasing output as a warning to rivals that if there is no agreement on a production freeze it has the means to continue raising its output and intensify the pain for all oil exporters.

Saudi Arabia may have resorted to volume warfare in the past to encourage agreement on output and punish non-compliance.

But a closer look at the kingdom’s recent production, consumption and export statistics paints a more nuanced picture.

At least this time around, there is no evidence that Saudi Arabia is raising production to intensify the pressure on its rivals to reach a production freezing agreement.

SEASONAL EFFECTS

Saudi oil production typically increases during the summer months to meet extra direct consumption of crude in the kingdom’s power plants.

In the past decade, Saudi oil production has been on average almost 400,000 barrels per day higher in July than January.

The production swing from January to July has been very variable, ranging from a reduction of 325,000 bpd to an increase of more than 1 million bpd.

But production has tended to increase seasonally by between 150,000 bpd and 650,000 bpd, according to the Joint Organisations Data Initiative (JODI).

In 2016, crude production increased by 440,000 bpd between January and July, which is squarely within the normal range.

Temperatures across the Arabian peninsula and neighbouring parts of the Middle East hit record levels during July and early August.

Strong air-conditioning demand is likely to have contributed to high combustion of crude oil and refined products such as diesel and residual fuel oil.

At the same time, Saudi Arabia has installed more gas-fired generating capacity and taken other measures to reduce direct crude burn in the power system.

Saudi Energy Minister Khalid Al-Falih said earlier this month oil production had risen “in part to meet the increase in seasonal demand during summer”.

“Domestic demand usually goes up during the summer due to increasing use of electricity for cooling,” he explained.

But he went on to note “this summer’s increase is lower than that of previous summers” owing to efficiency measures.

Published data show direct crude combustion was just over 700,000 bpd in June, significantly lower than in June 2015 (894,000 bpd) and June 2014 (827,000 bpd).

Data on direct crude consumption during the heat waves of July and August will only become available in September and October.

EXPORTS AND STOCKS

Saudi oil production has also been increasing to meet “higher demand from our customers”, according to the minister. “We still see strong demand for our crude in most parts of the world.”

Saudi crude exports averaged 7.456 million bpd in June, down by almost 380,000 bpd compared with January, but up by 91,000 bpd compared with the same month a year earlier.

Saudi crude exports have been fairly steady since 2014. The kingdom has successfully defended its volumes but has not increased them.

The rise in output during July (and hinted increase in August) was necessary because crude consumption and export sales had been outstripping output.

Crude oil stockpiles on Saudi territory declined every month between November 2015 and May 2016 by a total of more than 40 million barrels.

It is possible that oil stocks were moved from tank farms within the kingdom to storage facilities in the United States, the Caribbean, Singapore, China, Korea and Japan to be closer to customers.

But it is also possible the kingdom’s stockpiles have experienced a real drawdown. The energy minister may have hinted as much in his interview with the Saudi press agency published on Aug. 11.

“Last month, the supply figure of 10.75 (million barrels per day) was above that of production. Are you drawing down stocks?” the minister was asked.

“There has been a modest stock drawdown last month, which is expected during this time of year,” the minister replied.

“As the rebalancing process consolidates, we expect de-stocking to accelerate in all parts of the world.”

GREATER OPENNESS

Al-Falih’s carefully scripted interview with the Saudi press agency seems to have been an attempt to provide more insight and clarity about Saudi oil data to the wider market.

Unfortunately, it was poorly executed, with draft remarks leaking ahead of publication, and the discussion may have been too erudite, obscuring rather than elucidating the minister’s intended message.

But it appears to have been a serious effort at greater openness and a genuine attempt to improve understanding of Saudi production policy.

Most commentators seized on the minister’s remarks about being ready to “take action to help the market rebalance” in conjunction with OPEC and non-OPEC producers.

The Algeria meeting would provide a venue to discuss the market situation including any “possible action that may be required to stabilise the market”.

However, he also concluded: “Market rebalancing is already taking place but the process of clearing crude and products inventories will take time. We are on the right track.”