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Viktor Katona

Viktor Katona

Viktor Katona is an Group Physical Trader at MOL Group and Expert at the Russian International Affairs Council, currently based in Budapest. Disclaimer: views set…

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What The Saudi-Russian Alliance Means For Oil Markets

For the last three or four decades it would be very hard to imagine any sort of deep cooperation between Saudi Arabia and Russia. The two share a history fraught with letdowns, frequently making promises that fall far outside the realm of possibility. However, the OPEC+ deal has given rise to a new era of Moscow and Riyadh relations – with the two energy powerhouses not only ramming through an unprecedented 1.8 million barrel per day supply cut and substantially extending their political relations, but also looking into ways of investing in key energy projects together.

In order to understand the remarkable nature of the new Moscow-Riyadh axis, one need only look at the history of the two nations. The fall of the Soviet Union, which was heavily reliant on oil exports, was significantly impacted by the 1985 decision of Saudi oil minister Ahmed Zaki Yamani to ramp up production after almost a decade of strict production control. As the economy deteriorated against the background of falling income, so did the political environment. Afterwards, mistrust remained a problem between the Russians and Saudis, for instance, when the Saudi-led (perhaps it would be more precise to say controlled) OPEC tried to implement a supply cut in 1999, eliciting a pledge from Russia to cut output by 7 percent, Moscow backtracked on its vow and instead increased production.

For much of the 2000s, the Russia-Saudi Arabian relationship revolved around their vying for the top oil producer spot, a competition in which Russia managed to overtake the Saudis in 2009. The logic of the OPEC+ deal reshaped this relationship – Riyadh needed a serious partner to see the supply cut through, and without Russia on board the impact of the cut would be minimal and akin to economic suicide for the Saudis as Moscow would simply take over the market share that the Saudis would voluntarily cede. But Moscow needed Riyadh’s consent, too – at the time Saudi Arabia was the only international actor that could rapidly ramp up their production (it was and is alleged that Saudi Arabia’s surplus production capacity sits at around 1.5-2 million barrels per day).

Now, one and a half years into the OPEC+ supply cut, Russia’s NOVATEK and Saudi Aramco signed a partnership deal on LNG projects. It has been long rumored that the Saudis might be willing to take a share of the Arctic LNG 2 project, the follow-up of Yamal LNG. Related: Big Oil’s Trillion Dollar Data Battle

There is still no official confirmation of such a deal, however, all indications point towards this scenario – Saudi oil minister Khalid al-Falih stated that Riyadh could invest in Russia’s Yamal-Nenets Autonomous Region, home to Arctic LNG 2, whilst NOVATEK representatives reiterate the fact that talks with the Saudis are ongoing. NOVATEK has secured an initial agreement with CNPC for the three-train 19.8 MMtpa Arctic LNG 2 (the Chinese company’s stake in Yamal LNG 2 amounts to 20 percent), and is seeking another major investor to get it started.

For the Saudis, investing in Arctic LNG 2 should seem a relatively safe bet – against the background of a firm government buttress which saw the Russian government providing a light taxation regime for LNG projects, as well as constructing all the necessary urban infrastructure for Yamal LNG (quite costly in Arctic conditions). Arctic LNG 2 would not stricto sensu use the infrastructure of Yamal LNG, as it will be an offshore gravity-based platform on the other side of the Ob Bay, opposite the onshore Yamal LNG. However, the taxation conditions for Arctic LNG 2 are completely identical – a 12-year extraction tax exemption and no export tax. It still remains to be seen whether the Russian government will help NOVATEK with deepening the seabed beneath the platform or lower icebreaking fees for incoming vessels.

By opting for a gravity-based platform instead of an onshore plant, as per preliminary NOVATEK estimates, the cost of Arctic LNG will be 30 percent lower than that of Yamal LNG, despite the fact that its nominal production capacity is higher (19.8 mtpa against 17.5 mtpa). This might not turn out to be totally true, since this will be the first time that any company builds an offshore LNG platform in the Russian Arctic (further complicated by the fact that it will be built in a modular fashion, with most parts made in Russia) and the project might experience traditional Russian cost overruns, yet still the ambitious aims of NOVATEK are indubitably appealing to any major investor. But why is it Saudi Arabia, not some other company, Chinese, Indian or Japanese? A key part in the Saudi-Russian rapprochement is its reciprocity – Saudi interest in Arctic LNG 2 paves the way for Russian investment in Saudi LNG projects. Related: Germany’s Pivot From Russian Gas Will Be Costly

Russian participation in Saudi LNG might kickstart the nation’s long-sought gas pivot. Saudi Arabia’s electricity generation has been growing by an average 7 percent per year in the last 10 years (since 2000, its electricity output has almost tripled), yet Riyadh’s non-associated gas production, which according to Saudi officials should be one of the key resources for satiating the nation’s energy needs, is nowhere near domestic demand (grew by 3.9 percent in the last decade). As a consequence, Saudi Arabia still burns a sizeable amount of its oil (roughly 0.5 mbpd) to generate electricity, all of which could be exported. As Riyadh cannot export any gas from Qatar, a nation against which it has initiated a pan-Arabic boycott movement, it needs other partners to help satiate its gas needs.

If all this takes place with a fixed discount, all the better for the Saudis – hence, do not be surprised if you hear about a planned construction of a Saudi LNG terminal. Several years ago, Saudi Aramco looked into the possibility of building a LNG terminal on the Red Sea Coast (Yanbu or Jeddah were the most likely locations), so it is hardly surprising that NOVATEK expressed interest in such an endeavor. Investing into each other’s projects builds trust, which could ultimately lead to Russia’s labelling as a strategic partner in the much-awaited IPO of Saudi Aramco’s 5 percent share. The ongoing rapprochement does not mean that oil pricing battles will not be fought – they will, yet in case the tensions escalate to a higher degree, President Putin and Crown Prince Mohammad bin Salman will be there to cool the strains. All in all, there is much more to lose in case of an all-out conflict than with cooperation, albeit fraught with complexities.

Disclaimer: views set out in this article are solely those of the author in his private capacity.

By Viktor Katona for Oilprice.com

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