SURPRISE ENDING

September is the beginning of autumn, a time to analyse preliminary results and start new projects. If the same rules is applied to the global oil market and the outcome of OPEC+'s decisions adopted in the summer season, we can safely say that they turned out to be very effective.

Indeed, the decisions taken in June on voluntary oil production cuts by the key OPEC+ producers changed the situation on the oil market significantly. Oil prices continued to grow moderately over the past two months, staying within the $75-85 per barrel.

However, in September, the price of Brent rose above $91 per barrel after Saudi Arabia announced its plans to extend voluntary production cuts until the end of 2023 - for the first time since November 2022. Prior to this information, Brent and WTJ were trading at $88.4 and $85.3 per barrel, respectively. If the trend continues, the prices may well rise even to $100 per barrel.

Russia also contributed to this process by extending until the end of December 2023 the decision on additional voluntary oil cuts (by 300,000 bpd).

Double surprise

On September 5, Russia and Saudi Arabia surprised the world by announcing a cut in oil production and exports by the end of this year. As a result, oil prices reached ten-month highs. The total cap is 1.3mbpd, which is more than 1% of daily global demand.

Saudi Arabia is extending the oil production cut of 1mbpd until the end of 2023. This means that the actual level of oil production during this period will remain at 9mbpd.

"The voluntary decision to cut oil production will be reviewed monthly with the possibility of reducing or increasing production," Saudi Arabian state agency stated citing a source in the energy ministry.

Saudi Energy Minister Prince Abdulaziz bin Salman first announced the additional voluntary cut of 1mbpd from July 1, 2023 following the OPEC+ ministerial meeting in June, calling the decision a 'Saudi lollipop'.

The decision was supported by Moscow, which extended the reduction of oil supplies to world markets by 300,000 bpd until the end of the year.

Russia started to reduce oil supplies to the world market on August 1 (by 500,000 bpd). In September, it was decided to stop at 300,000 bpd. According to Alexander Novak, the average export level in May-June serves as the basis for the reduction.

He admitted that the reduction of Russian oil supplies is aimed at "strengthening the precautionary measures taken by OPEC+ member states to maintain the stability and balance of oil markets". By the way, Riyadh explained its decision in a similar way.

In both cases, these actions will add to the 500,000 bpd production cap announced in April, which will last until the end of 2024. Depending on the situation in the global market, the parties intend to review it on a monthly basis.

Three-digit level

Indeed, the joint Saudi-Russian announcement surprised many market participants. Mainly because previous cuts were prolonged for a month only. In comparison, the recently agreed period will extend until the end of the year against the earlier announced date (October 2023). As expected, oil prices jumped over the $91 per barrel.

"It was a stark reminder to investors playing down in the oil market that it's not worth trying to play against the 'oil central bank,'" Citigroup analyst Mike Tran said.

In recent weeks, prices have remained at $85-90 per barrel largely due to the joint Saudi and Russian measures to ensure voluntary oil cuts. Otherwise, there is simply no serious reason for such growth.

"Further supply constraints will support oil prices. We are likely to see a significant reduction in oil inventories as a result of these restrictions," analysts at ANZ Group Holdings Ltd believe.

Currently, Brent and WTJ are trading at $90.54 and $87.36 per barrel, respectively. The market's attention is gradually shifting to the September summits of the world's leading central banks.

"The oil rally deserves all the enthusiastic epithets, but it's off to a very interesting start. Quotations will be in limbo as the market assesses how central bank decisions will affect the situation," said John Evans, expert at PVM Oil Associates Ltd.

Goldman Sachs experts believe that the cost of Brent crude in December 2023 can be $2 above the bank's current forecast of $86 per barrel, if Saudi Arabia supplies 500,000 bpd less crude oil in the fourth quarter.

In the worst-case scenario, when OPEC+ keeps the agreed restrictions until the end of 2024, while Saudi Arabia very gradually returns oil production to 10mbpd, Goldman Sach's forecast for Brent for December 2024 may exceed $100 per barrel. However, the bank does not consider this scenario as a base case.

Gary Ross, head of Black Gold Investors LLC, believes that oil prices may continue to rise on the back of increased tourist activity in China and lower production by OPEC+ countries. Also, Brent is likely to trade in the range of $90-100 per barrel until the end of 2023.

"Domestic air traffic in China is already at 110% of pre-pandemic levels and international traffic has recovered to 75% of pre-pandemic levels. We are likely to see a significant increase in jet fuel demand, with China alone accounting for around 500kbpd. Road travel activity also looks positive, with long-distance journeys being made predominantly in gasoline-powered vehicles," Ross said. He believes that the extension of production restrictions by OPEC+ countries will lead to a significant reduction in global oil reserves.

Pros and cons

Moscow and Riyadh, the two main exporters of crude oil, are definitely happy with the reaction to their joint decision on the oil market. Both Russia and Saudi Arabia need high oil prices to receive more budget revenues, which means that we should not expect prices to fall in the next six months.

Saudi Arabia is cutting global supplies. After starting a voluntary curb on oil production, Riyadh announced in August a significant increase in the price of its oil in Europe and the Mediterranean, and unexpectedly raised the cost of supplies to Asia. The kingdom then raised almost all September prices for Asia and Europe.

Riyadh's goal is quite obvious: thanks to high prices, Saudi Arabia strengthens its financial position and builds up its foreign exchange reserves.

The current situation is also very favourable for the Russian budget. Analysts believe that Russia has an additional incentive to extend the voluntary cut, since the Russian crude oil brand Urals is being sold at a discount. Accordingly, apart from the Russian interest in higher prices for oil grades, increasing oil prices add to the value of Urals and even decrease the discount. Amid rising oil prices, the effectiveness of oil price ceiling for Russian oil is significantly reduced. According to London Stock Exchange Group (LSEG), Russian crude has been trading above the $60 ceiling since mid-July and is now shipping at $67 per barrel at oil terminals in Russia. The cost of oil has risen to $90, with Russian Urals averaging $74 per barrel in August, according to the Russian Finance Ministry.

High oil prices on the global market are very favourable for Azerbaijan, too. According to the forecasts of the Ministry of Finance, at an average oil price of $60 per barrel in 2023, the State Oil Fund of Azerbaijan (SOFAZ) will increase its revenues to ₼16.3b, at $70 to ₼17.5b, and at $80 to ₼18.7b.

Thus, the volume of assets at SOFAZ at an average oil price of $60 per barrel and assuming 100 per cent financing of planned expenditures will reach $51.7b by 2024. This means a 5.5% growth compared to 2022.

International institutions believe that in 2023 the price of Brent oil will not be lower than $75 per barrel, while the Azerbaijani authorities have set the average oil price in the state budget at $60 per barrel. Obviously, the current price is even higher than expected. But it is diffiocult to say whether it will remain at such a high level until the end of the year. We can only assume that the instigators of such growth will do everything to keep it at that level. However, we should not forget that with all the advantages of high oil prices for budget revenues and national economies of oil-producing countries, a rise above $100 will cause a new wave of inflation, including in exporting countries.