Gulf News - After oil cut decision, will Saudi Arabia land one decisive blow on short-sellers?

Dubai: Who’s winning the battle for the oil markets?

Just about two days after Saudi Arabia announced a voluntary 1 million barrel a day cut from July, oil futures took on an initial spike by 2 per cent - and now has retreated to hover around $75 a barrel, down 2.18 per cent.

The feedback from the markets? It’s too early to say when a decisive blow will be delivered by the Saudi decision against oil market’s short-sellers, who are betting that oil still has some way to drop.

So, what turn will the Saudi move in July take?

“Saudi Arabia announced a unilateral oil production cut of 1 million barrels a day for one month on June 4 - and held out the possibility that it might extend this,” said Jim Burkhard, Vice President and Head of Research for Oil Markets, Energy and Mobility, S&P Global Commodity Insights.

“In terms of world oil demand and supply fundamentals, the cut will likely expand a previously expected supply deficit in the third quarter of this year. Prices have been weak lately and the impact of this cut remains to be seen.”

The Saudi action of a unilateral cut – and then the possibility of extending it - was always on the cards ever since the Kingdom’s Oil Minister Prince Abdulaziz bin Salman took on the short-sellers. And by his recent statements, he was prepared to unleash all means possible to bring them to heel.

In July, Saudi output would drop to 9 million bpd.

“This is a Saudi lollipop,” Prince Abdulaziz said after the announcement was made on Sunday and quoted by Reuters. “We wanted to ice the cake. “We always want to add suspense. We don’t want people to try to predict what we do - this market needs stabilisation.”

No pulling the punches there.

How will short-sellers’ react?

“It is unlikely that Saudi Arabia’s voluntary production cut will deter short sellers - just yet,” said Bal Krishen, Chairman and CEO of Dubai-based Century Financial.

“Until there are compelling and consistent signs of economic revival, particularly in China, oil is likely to endure a demand-squeeze.

“Saudi Arabia needs oil prices to surpass $80/$81 to balance its budget and meet its spending commitments, which includes the $500 billion futuristic desert-city Neom.

Hinging on China

The short-sellers’ position hinges on a slowing economy in China, which is what Krishen was also alluding to. The recent PMI (Purchasing Managers Index) for the world’s second biggest economy had dropped to under 50, which is what signifies an economy that is under relative pressure on growth.

It ain’t China alone

Krishen points that PMI and possibilities of headwinds are cropping up in the US too.

“There is risk of a potential slowdown in future oil output growth in the US as energy companies dial back the number of operating rigs,” said Krishen. “Recent reports from the US reveal a contraction in manufacturing activity as the manufacturing PMI in May slipped to 46.9 – declining in 18 of the past 26 months.

“The ‘prices paid’ component tumbled into contractionary territory. This signals economic weakness in the near-term, which invariably implies further pressure on the outlook and demand for crude.

“Short-sellers of crude include more than just speculators in the current macroeconomic climate. The deteriorating fundamentals of the economy has sparked a risk-off sentiment and hammered volatile commodities like crude.

“More specifically, resilient Russian crude exports, subdued demand outlook, sluggish economic revival in China, and risk-off sentiment sparked by events like the debt ceiling deal – have paved the way for short-sellers.”

Let’s wait for July – and beyond

Oil industry sources say early-to-mid July would give a good indication of how the markets are factoring in the Saudi cut. And that too by a substantial 1 million barrels a day.

“More than that, it’s what happens after – will Saudi Arabia extend the cut,” said one analyst. “That’s where the real story breaks.”

If that recent history gets repeated, Saudi Arabia and Prince Abdulaziz bin Salman will have no complaints.

Prices well into the $80 plus and testing the $100 a barrel…