Teji Mandi : Saudi Arabia’s decision to reduce crude production to help OPEC manage inventory

05:06 PM Jan 20, 2021 | Teji Mandi

Saudi Arabia’s decision to reduce crude production will help OPEC (includes OPEC members along with Russia) to manage the inventory efficiently. But, it will put global crude prices on a boil. It, in turn, will impact the global economies and pockets of the common man alike.

The global oil market witnessed a very rare occurrence during the pandemic months. When the US ran out of storage space due to excess supply and zero offtake, the oil futures had dropped below zero. It was the first time in history as the U.S. crude oil futures had closed at a stunning USD -37.63 a barrel on that bizarre day.


The prices have recovered since then. Brent crude is currently trading at ~ USD 56 a barrel. The bounce back in crude is in line with the economic recovery playing out across the globe. An early forecast from Credit Suisse assumes that the oil demand could return to pre-COVID levels by the second half of FY22. Now, the prices are expected to shoot up further based on Saudi Arabia's recent decision.


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The OPEC leader has announced a cut of 1 million barrels a day of crude production for February and March. It shows Saudi's intent to protect prices by managing inventory.

High demand coupled with production cuts from Saudi Arabia will reduce the global crude inventory. As a result, the price will shoot up automatically. Assuming that oil demand will sustain, Saudi Arabia's decision will allow OPEC to normalize commercial oil inventories by late 2021.

The second covid wave or the slower distribution of vaccines continues to pose a downside risk to growing demand. But, we believe in any such event, OPEC is likely to respond with steep production cuts to manage the inventory.

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Refinery margins remain under pressure:

In a major sign of demand recovery, OPEC has reported increased user rates for refineries across the globe. US refinery use rates have increased in December 2020 to ~79.14%. In Europe, the average refinery user rate was at 65.32%. In Asia refinery use rates increased, averaging 89.83% in December.

Despite that, the improved refining usage, margin outlook remains challenging in the near term. Many refineries are still shut in light of weak demand. There is an anticipation that more closures will be needed if margins fail to improve.

Recovery in LNG prices:

LNG prices, on the other hand, have recovered sharply. Spot LNG prices by December end had recovered from $1.8/mmbtu in 2020 and finished the year at $14.6/mmbtu. The rally was owing to the increased demand while supply remained low. However, the market is now getting tight and demand is expected to remain subdued. It will be interesting to see how it affects prices.

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Closing comments :

Back home, Saudi's decision to reduce production will have a direct impact on the common man.

Fuel prices in India have remained high even when global crude prices were at a historic low. It is due to the extra surcharges levied by the government to make up for the loss in revenue.

As is the case, fuel prices are making new highs every day even now. There is no possibility of the government reducing the taxes anytime soon. Now, with global crude prices rising again, the common man must prepare for a further rise in fuel prices in the coming months.

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