Russia and Saudi Arabia have joined forces to cut production, but demand has far exceeded expectations. Since July, oil prices have risen by 20%.

After experiencing a prolonged slump of six months, oil prices have soared against the backdrop of tightening supply and rebounding demand.

Since July 1st, the international benchmark Brent crude oil has risen by about 20%, while New York Harbor diesel prices, as an important fuel for maintaining the global economy, have surged by one-third.

Saudi Arabia and Russia, the two major oil-producing countries, have made efforts to voluntarily reduce production to further limit capacity, while crude oil consumption has surged, resulting in a severe supply-demand deficit.

Severe supply-demand deficit for crude oil

On Tuesday, Saudi Arabia and Russia extended the voluntary production cuts until the end of this year. Saudi Arabia voluntarily reduced production by 1 million barrels per day, and Russia voluntarily reduced production by 300,000 barrels per day, driving oil prices to rise above $90 per barrel for the first time since November last year.

Specifically, starting from May this year, Saudi Arabia has reduced daily crude oil production by 500,000 barrels, and starting from July, it has voluntarily reduced an additional 1 million barrels per day. After these two reductions, Saudi Arabia's daily crude oil production has dropped to 9 million barrels. Russia's additional production cuts are less than one-third of Saudi Arabia's, and they apply to exports rather than production.

At the same time, crude oil consumption has surged. According to data from the International Energy Agency (IEA), global oil consumption reached a record high of 103 million barrels per day in June, with China's oil demand rebounding and driving overall demand higher.

Amrita Sen, an analyst at Energy Aspects Ltd, said in a report that the Western view of Asia, especially China, is far from reality, with strong end-user demand and refinery operations.

Against the backdrop of tightening supply and rebounding demand, the supply-demand gap has further widened, according to data from Rystad Energy A/S:

The supply deficit in the fourth quarter is about 2.7 million barrels per day, which means that global oil prices will further rise.

The market had hoped that seasonal changes would alleviate the tightness in the oil market. The IEA's previous forecast showed that the daily supply deficit in the fourth quarter was slightly higher than 1 million barrels, which is half of the estimated deficit from July to September. However, the joint statement by Saudi Arabia and Russia on Tuesday clearly changed this outlook, and the projected deficit for the last quarter is as severe as in the summer.

Emily Ashford, a commodity analyst at Standard Chartered Bank, also pointed out:

Our supply-demand model shows a severe deficit, and Saudi Arabia's production cuts have more influence than the so-called cuts by other countries. When they say they will cut production, they mean it.

Previously, the commodity research department of Goldman Sachs stated that the extension of the voluntary production cuts by Saudi Arabia and Russia could cause Brent crude oil futures prices to soar to $107 per barrel by the end of 2024.

Can Oil Price Surge be Avoided?

Next year, during the US presidential election, President Biden does not want to see a surge in gasoline prices. However, there are numerous obstacles to potential additional supply.

A three-way legal dispute between Iraq, the Kurdistan Regional Government, and the Turkish government has led to the closure of an important export pipeline. If Iraq can resolve this dispute, production could increase by 400,000 to 500,000 barrels per day. However, after six months of negotiations, a solution is still far off.

With the weakening of US sanctions, Iran has been increasing its production. In the first 20 days of August, Iran was shipping 2.2 million barrels of crude oil and condensate per day, and monthly exports in August are expected to reach the highest level this year. However, its export volume may have already reached its peak for this year.

Biden also has another potential tool to suppress oil prices - the Strategic Petroleum Reserve (SPR). Last year, the resources of the SPR were heavily tapped, resulting in a historic reduction of about 180 million barrels. When crude oil prices fell earlier this year, the US began replenishing the reserve. However, currently, US crude oil inventories continue to decline, and the number of supply days (including the SPR) has dropped to 46 days, the lowest level in 40 years.

Undeniably, the surge in crude oil costs will provide Saudi Arabia with more cash for priority investments, while also posing a threat to the fragile global economy, leading to a rise in inflation and potentially disrupting central banks' plans to ease interest rates.

Christof Ruhl, a part-time senior research scholar at the Center on Global Energy Policy at Columbia University, said, "Oil prices have reached a level that will impact overall inflation. This is not only something Biden won't like, but also something the Federal Reserve may have to react to."