February 01, 2024 [Reuters]- Saudi Arabia’s government on Tuesday ordered state oil company Aramco (2222.SE), opens new tab to halt its oil expansion plan and to target a maximum sustained production capacity of 12 million barrels per day (bpd), 1 million bpd below a target announced in 2020.

Saudi Arabia for decades has been the main holder of the world’s only significant spare oil capacity, providing a safety cushion for global supplies in case of major disruptions caused by conflict or natural disasters. In recent years, fellow member of the Organization of the Petroleum Exporting Countries the United Arab Emirates has also built up spare capacity.

The kingdom is the world’s largest oil exporter and is pumping around 9 million bpd, well below its around 12 million bpd existing capacity after it cut production as part of an agreement with OPEC and its allies last year.

Saudi Arabia, the de facto leader of OPEC, and Russia have spearheaded efforts with allies in the OPEC+ producer group to cut output to balance markets in the face of rising supply from other big oil producers, such as the U.S.

“Aramco currently has spare capacity of 3 million bpd,” a source with direct knowledge of the matter told Reuters. That gives Aramco plenty of scope to increase output if the market needs the oil, the source added.

If needed, Saudi Aramco could always boost its capacity target later, the source said.

“If the government decides to go the other way, the company is ready.”

Aramco’s lowered target did not reflect a change in the Saudi view of future oil demand, nor stem from any technical issue, the source said.

In the short term, there is unlikely to be strong enough demand for either Saudi Arabia or the UAE to pump closer to their capacity. OPEC has a more positive outlook on oil demand growth than other forecasters, and yet is expecting that most of the increase in demand over the next two years will be met by crude supply from non-OPEC+ producers.

In its latest monthly report, OPEC forecast that demand for its oil would grow about 1.3 million bpd by the end of 2025. That means the producer group would only be able to unwind a third of current OPEC cuts of close to 4 million bpd.

That would leave Saudi Arabia and the UAE sitting on sizeable spare capacity – which is expensive to build and maintain – at the end of 2025.

Benchmark Brent crude futures were little changed on Tuesday, trading up 0.9% at $83.12 a barrel by 1804 GMT.

Aramco shares closed up 0.2% at 31.30 riyals ($8.35).

Shares of top oilfield services provider SLB (SLB.N), opens new tab tumbled about 7% and those of its U.S. rivals also fell on the news.

Oilfield firms have been riding rising spending on international and offshore oil exploration and production, primarily from the Middle East and Africa, as U.S. shale firms keep a tight leash on drilling activity.

CAPEX U-TURN?

Saudi Arabia and the UAE have repeatedly called for more investment in oil and gas and argue fossil fuels will be part of the energy mix for decades to come, and that producers worldwide needed to share that burden.

Crown Prince Mohammed bin Salman during U.S. President Joe Biden’s visit to the kingdom in July 2022 warned that Riyadh “will not have any more capability to increase production” after it reached the now-scrapped 13 million-bpd goal. The kingdom had ordered Aramco to expand to that level in March 2020, when it was in a stand-off with Russia.

Major oil consumers, including the U.S. and the European Union, have adopted policies aimed at transitioning away from fossil fuels to cleaner energy which has discouraged investment in oil and gas amid concerns about future demand.

Analysts questioned whether Saudi has actually changed its long-term outlook on future oil demand and whether it may claw back on capital investment.

The lowered capacity target could reflect “a government expectation that demand for its oil will no longer rise as strongly as previously expected”, Morgan Stanley analysts wrote in a note.

“It may be to save money. But most likely it implies that it sees no need for this extra oil in the global market,” said SEB analyst Bjarne Schieldrop.

Aramco had said it expected capital expenditure of $45 billion-55 billion in 2023, the highest in its history, and indicated it would raise this in the years to come.

RBC Capital Markets analysts in a note on Tuesday said they expected Aramco to curb spending instead.

“All in all, we expect the capex budget could be lowered by (around) $5 billion per annum over the coming years relative to the prior guidance,” they wrote.

Projects without final investment decisions such as the 700,000-bpd Safaniya project “are likely to be deferred”, RBC said.

“We had assumed (a roughly) $12 billion budget for the Safaniya project, of which $3 billion was to be spent in 2024,” they noted.

Aramco is expected to provide an update on its capital expenditure plans when it announces its 2023 full-year results in March.

GROWTH AREAS

The lowered crude capacity target could spur momentum towards Aramco’s growth areas, such as gas and new energies, the source said.

Aramco made its first M&A foray into liquefied natural gas last year, buying a minority stake in MidOcean Energy for $500 million.

The state oil giant is also developing Jafurah, the kingdom’s biggest unconventional non-oil associated gas field, which in 2020 was estimated to require investments of $110 billion. It is potentially the biggest shale gas development outside of the U.S.

Some analysts said the lowered capacity could mean more money for other government projects.

Saudi Arabia has forecast a budget deficit of 79 billion riyals ($21.07 billion) in 2024, slightly smaller than a deficit of 82 billion riyals projected for last year as lower crude production and global prices reduced revenue.

Aramco in each of the last two quarters paid its shareholders near $10 billion in performance-linked dividends announced earlier in 2023, on top of Brent-linked royalties and $19.5 billion base dividends paid each quarter.

The Saudi state remains overwhelmingly Aramco’s biggest shareholder, and heavily relies on its generous payouts. The government directly holds 90.19%, the sovereign Public Investment Fund (PIF) 4% and PIF subsidiary Sanabil another 4%, according to LSEG data.

“Certainly, lower capex by Aramco provide scope to increase transfers to the government and the PIF to support the Vision 2023 objectives and the diversification of the economy, which we see as the main area of policy focus,” said Monica Malik, chief economist at Abu Dhabi Commercial Bank.

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