Oil traders were stunned this morning, when - in a huge reversal to its prior plans - the Saudi state ordered Aramco to stop work on expanding its maximum sustainable capacity to 13 million barrels daily, instead keeping it at 12 million bpd, ensuring that peak capacity will remain lower than projected rising demand for years to come, effectively pressuring oil prices much higher over the long run (unless of course the world figures out cold fusion in the next few years).
The company said in a statement today that its maximum sustainable capacity is determined by the state under a law from 2017. Aramco added that it would update its capital spending plans for the year in accordance with the new government directive in March when it announces its 2023 financial results.
Saudi Arabia currently has capacity for 12 million and is producing about 9 million a day, after it curbed output as part of OPEC+ efforts to revive the global oil market and prevent a surplus. Back in 2021, Saudi Arabia’s state oil company said it was working to boost its production capacity to 13 million barrels daily, a capacity expansion it predicted would come fully online by 2027 and in chunks, chief executive Amin Nasser said at the time.
The surprise move comes after the world’s biggest oil exporter had said in November that it was progressing “very well” with the multibillion-dollar project to boost capacity to 13 million barrels a day by 2027 as demand in China and India continues to grow.
The Saudi giant, the world’s biggest oil firm and the largest oil exporter globally, was working as fast as it could to reach that production capacity expansion, the executive said, noting that upstream investment has a long lead time.
According to Bloomberg, the change in the investment plan ordered by the Saudi government comes at a time when Aramco has significantly increased dividend payments to the state, its primary owner. The kingdom is running a fiscal deficit as it spends tens of billions of dollars on efforts to diversify the economy into areas such as sports and tourism.
The decision will take out a significant portion of the supply buffer that traders were expecting for later this decade, a gap that may be hard to fill by others. Maintaining additional spare capacity is expensive, especially when the country is already producing well below its maximum rate and demand growth is likely to slow with the energy transition.
Ironically, Aramco’s CEO has often warned the market that the industry is underinvesting in new oil supply, which, regardless of many scenarios, will continue to be needed for decades. Well, as of today the biggest underinvestor is none other than Aramco, whose move is seen as either a draconian attempt to contain supply capacity in the face of growing Indian and Chinese demand, or - according to the bears - a signal that said demand will simply not materialize.
“There is likely to be much speculation on the potential implications on global oil demand over the medium and long term,” RBC Capital Markets analyst Biraj Borkhataria said in a note. “This also marks a change in tone from one of the world’s largest oil producers at the government level.”
Borkhataria also expects the capex budget to be lowered by about $5b per year over the coming years relative to the prior guidance. Aramco will update its capital spending guidance when it announces annual results in March.
To be sure, despite extended and sizeable production cuts effected by Saudi Arabia and some of its fellow OPEC+ members, prices have remained stubbornly range-bound. This may be the reason for the new order. Alternatively, as noted above, the long-term outlook for oil demand in Riyadh may have changed.
Oil prices inched higher this week, following the latest news from the Middle East, which included a fuel tanker attack by the Yemeni Houthis and a deadly drone attack on U.S. troops. However, their gains were pared after the latest drop in Chinese stocks dented hopes that Beijing was finally getting serious about kickstarting its imploding market and economy.
The Saudi announcement will add to the list of uncertainties confronting traders. There’s no sign to the end of Israel’s war on Hamas, Houthi militants are menacing global shipping in the Red Sea, and there’s an increasing risk of Iran being dragged into the wider turmoil in the region.
Saudi Arabia’s latest move will likely have long term implications for the oil market. Curbing its growth plans would leave the kingdom with a thinner production buffer in the future in the event of supply shocks, especially in a volatile Middle East. Overall, it guarantees not only a much more volatile price but a much higher one as well, especially once the current production thrust (driven by relentless M&A) by US shale finally peaks.
European and Saudi drilling services stocks tumbled after the news of the Saudi expansion halt: Saudi-based Arabian Drilling and Ades Holding each fall as much as 10%, the most since their respective IPOs; both count Aramco among their main customers. In Europe, Saipem shares lose as much as 9.3; %Subsea 7 -4.4%; Borr Drilling -11%; Shelf Drilling -10%.