Saudi Arabia orders state oil giant Aramco to drop new drilling investment in major U-turn, sparking questions over demand peak

Saudi Arabia orders state oil giant Aramco to drop new drilling investment in major U-turn, sparking questions over demand peak

Finance ·Saudi AramcoSaudi Arabia orders state oil giant Aramco to drop new drilling investment in major U-turn, sparking questions over demand peakBYRakteem Katakey and BloombergA Saudi Aramco employee at the Khurais Processing Department in the Khurais oil field in Khurais, Saudi Arabia.Maya Siddiqui—Bloomberg via Getty Images

Saudi Aramco abandoned a plan to boost its oil output capacity, a huge reversal that will raise questions about the kingdom’s view on future demand.

The surprise move comes after the world’s biggest oil exporter had said in November that it was progressing “very well” with a multibillion-dollar project to boost capacity to 13 million barrels a day by 2027 as demand in China and India continues to grow. Saudi Arabia currently has capacity for 12 million and is producing about 9 million a day, after it curbed output as part of OPEC+ efforts to revive the global oil market and prevent a surplus.

“It’s the clearest sign yet that the kingdom is moderating its expectations of global oil demand growth in the coming years,” said Vandana Hari, the Singapore-based founder of Vanda Insights.

The change of plan — ordered by the Saudi government — will take out a significant portion of the supply buffer that traders were expecting for later this decade, a gap that may be hard to fill by others. But maintaining the additional spare capacity is expensive, especially as oil demand is likely to slow in the future with the energy transition.     

Aramco will update its capital spending plan when it announces annual results in March, according to a statement. RBC Capital Markets expects the company to lower its annual budget by about $5 billion from previous guidance. 

“Importantly, this also marks a change in tone from one of the world’s largest oil producers at the government level and there is likely to be much speculation on the potential implications on global oil demand over the medium and long term,” the bank’s analyst Biraj Borkhataria said in a note.  

While crude remains the backbone of the economy, Saudi Aramco is expanding in natural gas, chemicals and renewables. These businesses are likely to get a share of the money saved from the oil capacity expansion, a person familiar with the plans said.

The company is also expecting an additional 1 million barrels a day of oil supply to be freed up for exports by 2030 as a result of the kingdom’s wider domestic plan to stop burning oil for power generation.

The decision comes at a time when Aramco is paying much more in dividends to the government, even with its production being cut. The company — 98% state owned — raised its quarterly payout by more than $10 billion to $29.4 billion over the previous two quarters, as the government looks to fund its fiscal deficit.

Saudi Arabia will probably post a budget shortfall of about 4.3% of gross domestic product in 2024 and have more than $46 billion of funding requirements, according to Dubai-based bank Emirates NBD. That comes as the kingdom continues to spend tens of billions of dollars on tourism, sports and other projects championed by Crown Prince Mohammed bin Salman to diversify the economy.

Bloomberg Economics estimates that Saudi Arabia needs an oil price of $108 a barrel to balance its budget and meet domestic spending by the sovereign wealth fund. Crude in London is trading near $82 a barrel, holding largely steady as ample supplies from around the world counter a deepening crisis in the Middle East. 

The Saudi announcement will add to the list of uncertainties confronting traders. There’s no sign to the end of Israel’s war on Hamas, Houthi militants are menacing global shipping in the Red Sea, and there’s an increasing risk of Iran being dragged into the wider turmoil in the region.

Saudi Arabia’s latest move will likely have long term implications for the oil market. Curbing its growth plans would leave the kingdom with a thinner production buffer in the future in the event of supply shocks, especially in a volatile Middle East.Play Video

But in the shorter term, the market doesn’t need Saudi production capacity at 13 million barrels a day because there’s ample levels available after the Organization of Petroleum Exporting Countries reduced output, according to Amrita Sen, director of research at consultant Energy Aspects Ltd.

“We have to ask ourselves the question – over what timeline” Aramco keeps the lower capacity, she said on Bloomberg Television.