Oil: Saudi Cuts Vs. Central Bank Hikes – Who’ll Win?


  • As Saudis double down with cuts, central banks will go the other way with rates
  • Hard to make a call on oil prices as the West still growing despite recession mantra
  • Ultimately, Saudis might flood market if all gambit for higher prices fail
  • InvestingPro Summer Sale is on: Check out our massive discounts on subscription plans!

In a perfect world, would be $80 a barrel now, $90 in July, and $100 in August. You know what I’m going to say next — there’s no such perfect world. You also know there’s nothing profound in that and neither do I feel like the smartest guy in the room saying it.

But I’m going to urge you to think a little deeper about two things.

The first is the Saudis have pledged to cut a million more barrels per day from their output in July and will continue doing so until they see the price per barrel they want or they get to “balance the market” (the latter is the bull they normally feed us to mask the impression of them being price hawks).

The second thing you need to consider a little more intensely is that the , the , and the seem determined to slay the inflation beast and have pledged to keep raising rates as long as necessary to achieve that. And we know that higher oil prices feed into higher inflation.

Now, put the two things together: The Saudis will cut as much production as necessary in the coming months to get the oil prices that they want while the central banks respond, albeit with some lag, with commensurate rate hikes each time inflation becomes a threat. We also know there is a positive correlation between oil demand and economic growth and the higher rates go, the greater the chance of them slowing economies as a whole and causing recessions.

So, now comes my question to you: Who do you think will win this game?

Feel free to articulate your thoughts in the comments field but my answer is: Neither side is going to really get what it wants.

The popular theory is that the core inflation watched by central banks is free of volatile food and energy prices. The reality is higher oil prices would have already impacted the larger economy even before the energy component is stripped out. So, whether it’s headline or core inflation, both are correspondingly higher with pricier oil.

The Saudis will probably get the $80 per barrel that they seek at some point next month and may see even $90 if there’s a major disruption in supply in any part of the world, or if demand for oil — typically stronger in the summer than any other season — gets insanely high.

Lower Lows Likely for Oil Prices, Rather Than Higher Highs

If that were to happen, there’s also a great likelihood that the resultant inflation from such oil prices will trigger the Fed, ECB, and BoE into further tightening. Thus, any oil rally will probably be moderated before not too long, and crude prices could see lower lows, rather than higher highs.

Simply put, there’s just no easy way to call oil prices at this moment because of real dynamic economies in the West that are still registering growth despite Wall Street’s recession mantra, the latest prophesied on Tuesday by HBSC which expects a U.S-to-European slowdown to begin by the fourth quarter.

Phil Flynn, energy analyst at Chicago’s Price Futures Group one of the most ardent oil bulls out there, commiserated about the fate that’s beseeched those long crude in a note issued Tuesday:

“The war on inflation is causing the market to look beyond the current fundamentals for oil as they count on a recession to equalize supply. More [Wall Street] banks are calling for the Fed to get more aggressive.

Morgan Stanley’s call is for the Fed to raise interest rates by a 25-basis point hike in July raising the terminal rate to 5.375% versus the 5.1% that they previously had predicted. Speculation that the Fed was done raising rates seems to be off the table for now and instead of taking the leadership role, the U.S. Federal Reserve seems to be following the ECB president Christine Lagarde back into its aggressive interest rate hiking phase.”

U.S. oil demand, meanwhile, was at its highest last week since December 2020, Flynn noted.

“On the flip side of that we’re seeing signs that the demand for oil currently is far from recessionary levels. JPMorgan reported the global gasoline demand growth of 365,000 barrels a day year over year and that was driven by strong U.S. gasoline consumption and now with consumption at an 8-week high of 9.4 million barrels a day and predictions that we will see a record-breaking 4th of July holiday, one would expect that those demand numbers could exceed 10 million barrels a day at least for the holiday.”

To me, some of the mind-boggling growth in U.S. employment now is due to companies and businesses spending on hiring the remnants of money handed out during three years of pandemic relief. You have a labor market that’s not going to retreat easily. Along with that market’s charge, the economy is bringing along the power of pricing.

OPEC and Central Banks Only Have One Tool Each to Sway Markets

That power is exactly what the Fed officials don’t want the economy to have now. They want the good part of the economic boom — the growth — but not the bad part — the inflation. The central banks are in the same situation as OPEC. Just like how the cartel has only one tool — control of supply — to calibrate demand and prices, central banks have also just one resort: rates, which they can either raise or cut, to prompt the economy into desired action.

Both sides are going to try and use the singular tool in their possession to gain maximum advantage.

OPEC can argue that the current inflationary problem is a pandemic-era excess, caused by the United States’ spending of trillions of dollars on relief programs that were overextended for anyone’s good.

It can accuse the Fed of being lax, sleeping at the wheel, and trying to catch up by blaming OPEC and pricey oil for the situation. I’ll accept that argument. What doesn’t change is that if go now from $70 to $90, it’s not going to make the situation any easier for the central banks.

With demand from China not coming in as expected, the only way for the Saudis to get oil prices will be to keep dropping production while the Fed and its peers jack up rates to try and quell that inflation monster.

So which of the two is greater in force?

As much as oil demand is touted to be inelastic, what needs to be remembered is that the consumer doesn’t have a bottomless abyss for a wallet, nor an infinite threshold of pain for inflation.

If the Saudis think they are better off selling fewer barrels for higher prices, then the question really is how many will be willing to pay, say $100, per barrel? It could be fewer than they think. Demand is going to drop for sure.

If all fails, the Saudis will likely flood the market with supply as they always do to punish the world for not following their way. They did so three years ago when the Russians refused to come on board with more production cuts just before the pandemic. The result was a WTI that went to minus $40 per barrel.

The problem for the Saudis this time is that the shale patch is no longer majority-owned or run by shaky independent producers who barely can resist prices below $40. Now, shale is a game involving the ExxonMobils and Chevrons.

Three years of price turnarounds and cash conservation have left shale drillers with much deeper pockets to withstand a price war. And incredible improvements in drilling efficiency — the tumbling U.S. oil rig count versus higher production is proof — have brought producer cost per barrel down to the low $30s now.

Said John Kilduff, partner at New York energy hedge fund Again Capital:

“The Saudis really need consistently high oil prices to keep plonking hundreds of billions of dollars into their economic diversification away from oil. Creating another 1970s-style oil crisis, where you’d have the world begging at your feet for barrels while you gloat, may not be that easy.”


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Disclaimer: The content of this article is purely to educate and inform and does not in any way represent an inducement or recommendation to buy or sell any commodity or its related securities. The author Barani Krishnan does not hold a position in the commodities and securities he writes about. He typically uses a range of views outside his own to bring diversity to his analysis of any market. For neutrality, he sometimes presents contrarian views and market variables.

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