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Saudi Arabia and a handful of other countries stunned the world on Sunday by announcing significant cuts in their oil production – totaling more than a million barrels of oil per day – starting in May.

The decision was unexpected because it did not come as a typical, negotiated OPEC+ agreement reached at a regularly scheduled meeting. Instead it was undertaken by Saudi Arabia and other producers including the United Arab Emirates and Iraq, and announced without warning.

"It was a massive surprise to everybody in the market," says Jorge Leon,  a senior vice president at Rystad Energy. 

Oil markets have responded with a price jump ...

Brent prices, the global benchmark, jumped up around $5 to around $85 a barrel immediately on news of the cuts. Reducing oil production means less supply on the market, which obviously pushes prices higher. 

Because the cuts are planned to last from May through the end of the year, the effect on oil prices is also expected to be prolonged.

"Overall, we think that oil price says might increase by around 10 percent going forward compared to what we had," says Leon, of Rystad Energy. "That's a significant increase."

Crude prices dropped sharply last month, driven by the turmoil in the banking sector. That hurt the budgets of countries like Saudi Arabia, which rely on oil revenue. And cutting production was a reliable way to bring prices back up. 

For the record, Saudi Arabia said the cuts were a "precautionary measure aimed at supporting the stability of the oil market." The kingdom consistently denies that production decisions are made with a specific price target in mind. 

However, oil analysts interpreted the surprise production cuts as a clear signal that Saudi Arabia and close allies were setting a floor for crude oil prices, below which they would take actions to prop them up.

Gasoline prices are expected to go up, too

Crude oil prices are a major driver of gasoline prices, so as the price of oil goes up, gasoline prices often follow, delayed by days or weeks.

That's what happened last year when oil prices surged, sending the national average price for gasoline to a record of as much as $5 per gallon.

Prices had come down significantly since then, to $3.50 per gallon, according to AAA.

It's hard to predict exactly how much prices will rise now, because there are other factors at play, including refinery outages, changes in demand and general economic conditions. 

The cuts come amid tensions with Saudi Arabia

Saudi Arabia and the U.S. have long been allies. But the relationship has been strained, including by recent decisions made by the kingdom and OPEC+ about oil production and prices. 

President Biden made a high-profile trip to Saudi Arabia last year to ask for an increase in oil production, seeking to bring down high gasoline prices. He was rebuffed. 

His administration issued a statement on the latest cuts, calling them not advisable. 

Meanwhile, Saudi Arabia is growing closer to China, economically (including through oil deals) as well as diplomatically. 

Analysts at RBC Capital Markets, who have traveled to Riyadh several times in recent months, wrote that the Kingdom of Saudi Arabia now sees the U.S. as "just one of several partners," while the relationship with China grows more important. 

"China is already the Kingdom's most important trading partner and the country's economic future is seen as residing in the East," they wrote. 

For U.S. oil companies, this is a boost — and an opportunity

The U.S. is the world's largest consumer of oil, by a long shot. That means rising prices for oil and gasoline hit American pocketbooks hard. 

But the U.S. is also the world's largest producer of oil. And for companies that sell crude, a Saudi production cut means a big windfall. 

On Monday, energy stocks had their best day on Wall Street in months. 

It's also an opportunity — hypothetically, American oil producers could boost their output to take market share from the Saudis. President Biden attacked oil companies last year for raking in record profits while not doing enough to raise production. 

However, there are an array of forces that are keeping U.S. production in check right now. 

Last week the Dallas Fed released its quarterly survey of oil companies. Executives described trouble raising money and hiring workers, as well as cost inflation, frustrations with the government, disruption by climate activists, and a general atmosphere of uncertainty as factors restraining their production right now. 

Business and Economic News

Transportation

Camila Domonoske

Author

Oil prices surged after Saudi Arabia and some other oil producers announced they're reducing their oil output. That will send gas prices higher – and benefit energy companies in America.

5 things to know about Saudi Arabia's stunning decision to cut oil production

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