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Saudi dealmaker

Fiscal pressures and the Aramco IPO were behind the Saudi change of heart. Riyadh needs this deal to work

The Gulf Cooperation Council (GCC) as a whole is keen to promote the Opec and non-Opec commitments to reduce oil production - the open-the-floodgates policy now barely mentioned - and Saudi Arabia is the Gulf's chief cheerleader. The kingdom, which had been producing at record high levels during 2016, accepted an output cut of 486,000 barrels a day, giving it a new target of 10.058m b/d.

So keen is Saudi Arabia that it be seen to be leading from the front that energy minister Khalid al-Falih couldn't resist telling reporters in early January that not only was the kingdom's output already below 10m b/d, but it was "going the extra mile to lead our colleagues within and outside Opec to make sure the market sees that there is serious action". Later, Falih stressed again that Saudi Arabia would "strictly adhere" to its commitments, producing at the target level or "as is the case now, slightly below".

Only when data for January becomes available will it be clear exactly how much Saudi Arabia has cut. But at the moment the key point is that the GCC states as a whole are talking up the accords as much as they can - in Saudi Arabia's case with the passion of a new convert.

For this time last year, with Ali al-Naimi still in the oil hot seat, the kingdom was arguing strongly against the need for market intervention to underpin prices. At the Doha meeting last April, efforts to coordinate a freeze with Russia and other producers collapsed when deputy crown prince (and economy/energy supremo) Mohammed bin Salman pulled the plug when it was clear Iran was not making a similar commitment. Naimi's public humiliation was the prelude to his replacement by Falih.

Since then, Saudi Arabia's view on the oil price and the merits of market intervention have been coloured by several factors. First, it wanted to restore Opec's credibility and the kingdom's leading position within the organisation. Second, fiscal pressures were growing, with a mounting budget deficit, continuing depletion of foreign reserves and an expensive war in Yemen to be financed. Saudi leaders also had an eye on the planned 5% Aramco IPO in 2017. Higher oil prices would increase the value of the company.

Energy diplomacy

With all that in mind, Falih embarked on nine months of intense energy diplomacy. Some oil producers, like Venezuela, were clearly suffering more than others from the impact of low prices. But all were unhappy with the idea of a barrel of oil selling for only around $30. On the other hand, finding a mechanism that all could accept and persuading non-Opec states to join a price cut proved difficult and time consuming.

Indeed, Saudi Arabia has invested so much effort in achieving its goal - crowned by the successful Opec meeting in November 2016 and two weeks later by non-Opec states - that it is determined to ensure the project's success. Thus the particular enthusiasm of Saudi Arabia and its Gulf allies in singing the praises of the deal.

Over the course of the six-month agreement period, Saudi Arabia will implement production cuts in part by taking the opportunity to carry out refinery maintenance and repair programmes, while reducing output across a number of fields, a common practice during the winter months of less intense oil demand.

Saudi officials are realistic about the chances of full compliance to the output reduction deals, and will be content if 60-70% of the targets are met - provided that oil prices remain above $55 a barrel. At the same time, they will be ready to turn on the taps to compensate for any sudden disruption of supply from a major producer as a result of war or natural disaster.

For now, Saudi Arabia is happy with the way things are going. The price rises so far have provided a boost to the budget. But the kingdom will be waiting to see how the US shale industry reacts to recent developments and what impact its response has on oil prices before deciding on what strategy its Opec and non-Opec partners should adopt when the current six-month agreement expires.

Falih is confident that the measures taken so far will be sufficient for producers to achieve their goals. He said in mid-January he thought it was "unlikely that we will need to continue" the production cuts, adding: "Demand is going to pick up in the summer, and we want to make sure the markets continue to be supplied well." Expect more encouraging and optimistic pronouncements from the Saudi minister in the weeks and months ahead.

PE verdict: Saudi Arabia will backstop the deal, but doesn’t want too big a price surge.

This article is part of a report series on Opec. Next article: Baghdad blurs the picture

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