Oil rally under threat as Saudi Arabia prepares to raise output

Brent, the benchmark for Nigeria’s crude oil is set to face fresh threats as Saudi Arabia plans to increase oil output in the coming months, reversing a recent production cut, the Wall Street Journal reported on Wednesday, citing advisers to the country.

Saudi Arabia surprised the oil market in January 2021, when it will cut 1 million barrels per day of oil of its own production in the months of February and March, after a day of tense negotiations with Russia and other oil producers.

However, the world’s largest oil exporter plan to announce a reversal of those cuts when Organisation of Petroleum Exporting Countries (OPEC) members meet next month, although the output rise won’t kick in until April, given the Saudis have already committed to stick to cuts through March.

All eyes will now be on the next meeting of OPEC+ early next month, when a key decision will have to be made about future supply.

What does it mean?

Additional cuts are supportive for the market, particularly given that these additional cuts are meaningful, however, the absence of this cut means more supply in the market which could lead to lower oil price.

Saudi Arabia surprise cut in January help offset some uncertainty related to Covid-19 over the first quarter of this year, with several countries imposing new lockdowns or extending current ones.

Clearly these lockdowns are a concern for oil demand and are certainly something that Saudi Arabia recognised as a key risk for the market moving forward.

The propose action taken by Saudi Arabia, along with the bulk of other OPEC+ producers maintaining current output levels means that the oil market should continue to drawdown inventories over 1Q21, and as a result oil prices would face further pressure.

In terms of impact on the industry, any action taken by OPEC+ to support prices would be decisive to US shale producers, with the boost in price potentially seeing producers more comfortable in increasing drilling activity.

What risks remain?

In the current environment, there are several downside risks, and obviously a key risk remains Covid-19 and how the situation evolves in the months ahead, as countries wait to receive vaccines.

New strains of the virus are a concern, however, for now, there is no suggestion that vaccines will not protect against these new strains, but this could easily change.

Away from Covid-19, another risk for the market is that other OPEC+ members get frustrated that Russia and Kazakhstan are increasing output, while they are keeping output unchanged.

Therefore, there is the risk that other producers start to let compliance slip, particularly if they feel that Saudi Arabia will pick up the slack.

Finally, there remains a risk around how quickly Iranian supply could return to the market. However, given the recent news that Iran has increased its uranium enrichment, it is less likely that we see the US lifting sanctions against Iran anytime soon.

Implication for Nigeria

For most OPEC members, more supply in the market without a corresponding increase in demand is bad news for the global energy industry laid low by the demand-sucking pandemic.

Nigeria needs the oil price to rise and in the worst case, remain steady at any price above the $40 benchmark of the 2021 budget while also maintaining oil production estimate of 1.86 million barrels (inclusive of condensates of 300,000 to 400,000 barrels per day).

“We think an above US$40/bbl Brent price remains healthy for the 2021 budget revenue projections which is critical to achieving the historic revenue numbers projected in an ambitious budget,” analysts at Lagos-based CSL Stockbrokers said in a research note.

Nigeria, Africa’s largest economy depends on earnings from oil to finance its N13.588 trillion 2021 budget.