What are the implications of Saudi Aramco's pause in expansion?

Aramco has cancelled plans to expand its maximum sustainable capacity from 12 to 13 million barrels per day by 2027. Reuters

It’s like the entire oil industry of Oman or Angola was turned on and then off again.

Saudi Aramco, the state oil giant, said on Wednesday that the Ministry of Energy had told it to cancel plans to expand its maximum sustainable capacity (MSC) from 12 to 13 million barrels per day by 2027.

Speculations on motivation have abounded. Is this an attempt to drive up longer-dated future oil prices, a recognition that future demand will be weaker, or an acknowledgement of unexpectedly strong expansion from competitors? Is it to save cash? Is there a political angle?

The higher target had originally been announced in March 2020, as the Covid-19 pandemic hit, with Saudi Arabia locked in a battle for market share. So perhaps it’s not surprising that four years later and with much water under the bridge, it’s time for a rethink.

There are good reasons for Aramco to dial back its MSC expansion. There are also major implications, both with the decision itself and with its communication.

What are the good reasons? First, there is no obvious immediate need for more oil. With Saudi Arabia’s voluntary cuts, national crude output in December was about 9 million bpd, while Aramco’s capacity is 12 million bpd, plus about another 0.2 million bpd from the country’s half-share of the Neutral Zone with Kuwait.

Opec has a bullish outlook on global demand. It sees demand rising 2.3 million bpd this year and 1.8 million barrels next year, both well above long-term historic average growth rates, then slowing but still adding a total of 10 million bpd by 2030.

Most other forecasters are more conservative, because of improving efficiency, climate policy and the effect of electric vehicles. But even on the aggressive outlook, Saudi Arabia could maintain its market share by producing less than 11 million bpd in 2030, leaving more than 1 million bpd spare.

This demand outlook also conceals more than it reveals. Growth is expected to be driven by petrochemicals, which will be met more by natural gas liquids, a by-product of growing natural gas production, rather than crude oil.

Saudi Arabia, through the development of the Jafurah unconventional gas resource, will add 0.63 million bpd of NGLs and condensate by 2030, not included in its crude oil target.

Biofuels, made from crops, and food and agricultural waste, are also growing fast, driven by government mandates and airlines’ need to cut greenhouse gas emissions.

Global use of crude oil, strictly defined, is probably already past its peak.

On the production side, there is additional spare capacity within Opec+, particularly in the UAE. Iran’s greater ability to sell despite sanctions has allowed its output to rise strongly over the past year, as it is not bound by quotas. In a recent interview, the Kuwait Petroleum Corporation chief, Sheikh Nawaf Al Sabah, outlined his plans to expand capacity after years of decline. Kazakhstan, with a new strategy announced in December and, despite obvious political challenges, Iraq and Libya, also intend to boost output.

The competitors to the Opec+ group have grown unexpectedly even more strongly over the last year, with particularly the US, Brazil and new entrant Guyana contributing.

Meanwhile, Qatar announced an expansion of its biggest field, Guyana’s neighbour Suriname should start offshore output in 2028 and, by 2029-2030, large discoveries in Namibia may come into play.

Second, pushing back Aramco’s higher capacity will save or at least delay some capital expenditure. That frees up cash for dividends or other business activities, with the corporation having announced a string of large downstream investments as well as venture capital allocation in the past few months.

The Saudi government, investing heavily in domestic growth as well as foreign projects, will welcome some additional cash inflows. A further possible sale of some government shares in Aramco would be supported by a solid dividend outlook.

Third, the announcement isn’t all that it seems. It was underpinned by the expansion of the Dammam field – the kingdom’s first, discovered in 1938 – but more by the large Berri, Marjan and Zuluf fields, totalling 1.2 million bpd. For now, it seems that those projects are continuing.

Aramco's oil field in the Empty Quarter, Shaybah in Saudi Arabia. Reuters

So, instead of keeping up capacity at other fields through additional drilling and secondary or enhanced recovery methods, Aramco will allow them to decline. Without heavy ongoing investment, its current capacity of 12 million bpd would fall to about 10.5 million bpd by 2027, emphasising the importance of the expansion projects in bridging most of that gap.

But if circumstances change and new production is needed imminently, Aramco will have most of the production facilities and infrastructure in place at its older fields as well as at the expanded ones. Given a few months or a year’s notification, it could step up drilling and expand towards 13 million bpd.

The original intention was to maintain the 13 million bpd over the longer term by working on Safaniyah, the world’s biggest producing offshore field, and the large Manifa heavy oilfield. Those are the projects that now seem to be shelved. If circumstances change again, they would take longer to revive and complete – likely three to four years.

Those are the solid reasons for the decision. But, it brings potential challenges. It may have been unavoidable to announce the scrapping of the target, given that Aramco is a listed company. Nevertheless, it gives very public encouragement to all its competitors to expand their own production into the late 2020s, with less fear of being undercut by Saudi Arabia.

The game isn’t to produce every last barrel but to gain the most value over the long term. Nevertheless, it will be a concern to Riyadh that while demand is still growing strongly, its output is not. That suggests that the implicit price band Opec+ has had in mind is too high.

In the coming few years, Saudi Arabia may need to return to a more aggressive policy on price, and a revival at least of the possibility of higher capacity.

Robin M. Mills is chief executive of Qamar Energy and author of The Myth of the Oil Crisis