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Saudi Arabia Suckered Again By Russia In OPEC+’ s Output Cut

As predicted in my article at the end of May - partly because Russian Deputy Prime Minister and key OPEC+ negotiator Alexander Novak clearly indicated that OPEC+ would definitely not announce a surprise cut in oil production - OPEC+ did announce a surprise cut in oil output at its meetings beginning 4 June. As also predicted in the same piece, the net effect of the 1.16 million barrels per day (bpd) production cut achieved nothing good for Saudi Arabia - either through the sustained oil price gains it anticipated or in repairing its shattered geopolitical relationships with the West. Instead, as with the previous 'surprise' OPEC+ production cut, Russia was the only major beneficiary. The key question from this point for the oil markets is where does this key energy relationship go from here? The genesis of the Russia-Saudi Arabia relationship as it pertains to the transition of 'OPEC' to 'OPEC+' (the major '+' in this context being Russia, of course) is core to understanding why Saudi Arabia keeps being suckered in to doing stupid things in the oil markets by Russia. This is entirely separate from the reasons why Saudi Arabia keeps being suckered in to doing stupid things by China, which are analysed in depth in my new book on the new global oil market order. The catalyst for this seismic shift in geopolitical alliances between Saudi Arabia and Russia was the failure of the 2014-2016 Oil Price War, as also analysed in the book, which was launched with the specific intention by Saudi Arabia to destroy - or at least severely disable for as many years as possible - the U.S.'s then-nascent shale oil sector. It was obvious to the Saudis at that point that ongoing build-out of the lower-cost U.S. shale oil sector would mean the gradual destruction of Riyadh's power in the world and as a key player in the Middle East, given that its only true basis of power is its oil supplies. It would also mean that the U.S. would be less inclined to support Saudi Arabia on regional security issues, most notably the increasing threats from Iran. In short, the Saudis had no real choice but to try to take on the U.S.'s shale sector, and it did, and it lost and it - and every one of its OPEC brothers - paid a terrible economic price, further exacerbated by the 2020 Oil Price War.

Related: Pentagon Papers Show Saudi Arabia, U.S. Traded Threats Over Oil

The immediate aftermath of the 2014-2016 Oil Price War was that Saudi had devastated its own economy and those of other OPEC member states for years to come. Additionally, and more importantly from a geopolitical perspective, it had lost its credibility as the de facto leader of OPEC, and OPEC had lost its credibility as the indomitable force in global oil markets. This meant that OPEC's pronouncements on future oil supply and demand levels - and therefore, on pricing - had lost much of their potency to move markets, and that their joint production deals were diminished in effectiveness. At the end of 2016, then, and fully cognisant of the enormous economic and geopolitical possibilities that were available to it by becoming a core participant in the crude oil supply/demand/pricing matrix, Russia agreed to support the OPEC production cut deal in what was to be called from then-on 'OPEC+', albeit in its own uniquely self-serving and ruthless fashion.

It is to their moral credit that the Saudis appear never to forget what they consider to be a good deed done for them, as also occurred in China's case with the face-saving offer made to Crown Prince Mohammed bin Salman when he was struggling to find big buyers for his initial public offering of Saudi Aramco. As also examined in depth in my new book, China's offer to buy the entire 5 percent in the company being offered at that time in a private placement - the details of which were never to be revealed - was the key turning point in the relationship between Saudi Arabia and China. Similarly, Russia's support for the end-2016 'OPEC+' oil output cut was effective in bolstering oil prices and allowing OPEC members to begin to rebuild their finance after the 2014-2016 Oil Price War. It was also the key turning point in Saudi Arabia's relationship with Russia.

Following this, October 2017 saw Russia's President Vladimir Putin invite Saudi Arabia's King Salman bin Abdulaziz al-Saud, to Moscow - the first ever visit to Russia's capital city made by a sitting Saudi monarch. At this meeting, and the many meetings on the side-lines between officials of the two countries in which the real business is done, US$3 billion or so of specific deals were agreed across a wide range of areas, not just in the oil sector. Russia's Energy Minister Alexander Novak flagged at the time that Russian gas producer Novatek was in talks for Saudi investors to take part in its Arctic LNG-2 project, a follow-up to its US$27 billion plant in the Yamal peninsula. It was also agreed that Saudi Arabia's sovereign wealth fund, the Public Investment Fund (PIF), was to establish a US$1 billion fund alongside Russia's sovereign wealth fund, the Russian Direct Investment Fund (RDIF), which would invest in Russian technology companies. In the same vein, Russian state-owned hydrocarbons companies Rosneft and Gazprom entered talks with their counterpart, Saudi Aramco, to conduct co-ordinated oil and gas trading operations and the establishing of a joint research and technology centre. 

Bad though all of this was from Washington's perspective, even worse were two broader political and military developments, as also analysed in depth in my new book on the new global oil market order. One of these was that Saudi Arabia rowed back on its demand that Syria's President Bashar al-Assad be removed from power. The other, and perhaps even more extraordinary, was that Saudi Arabia signed a memorandum of understanding for the purchase from Russia of its S-400 air defence system. The apotheosis so far of Saudi Arabia's profound commitment to Russia has been its unerring unwillingness to in any way downscale this relationship in light of the invasion of Ukraine in February 2022, of course.

The problem for Saudi Arabia and its fellow OPEC brothers is that Russia regards them all as - in the phraseology of the original KGB in which Putin was raised - 'useful idiots'. For many years up to its invasion of Ukraine, Russia had a fiscal breakeven price per barrel of Brent of around US$40. This was for a long period about the same as the level at which U.S. shale producers can make decent profits and around half of Saudi Arabia's longstanding fiscal breakeven oil price. Things have changed now, with a fiscal breakeven oil price for Russia of around US$115 pb of Brent this year, according to oil industry figures. But this is not the key point. The key point is that following Russia's invasion of Ukraine, various bans and price caps were introduced on its hydrocarbons products by differing groups of the U.S. and its allies, with a central one being the introduction of a general oil price cap on Russian oil at US$60 per barrel. This came in December from the G7 group of countries (comprising Canada, France, Germany, Italy, Japan, the UK, and the US) and from the EU (which is also a 'non-enumerated' additional member of the G7), plus Australia. Given these factors, Russia's strategy has been very straightforward, but very effective: persuade Saudi Arabia (the de facto leader of OPEC) to increase the group's oil prices as much as possible while at the same time selling its own oil at a discount to this price, above the official oil price cap. 

There are plenty of willing buyers for discounted Russian oil whether it is at or above the US$60 pb barrel price cap. China is the main one, but India is a huge buyer too - and the higher OPEC puts up its oil prices, the more attractive discounted Russian oil looks. As also analysed in my new book on the new global oil market order, neither China nor India (nor several other major oil-buying countries) care at all about existing U.S.-led sanctions against Russia and are happy to buy cheap Russian oil. Interestingly as well, the U.S. itself does not seem too bothered about such sales at discounted prices to the OPEC levels because this has the net effect of subduing oil prices generally within the wider global oil market. It is in this context, then, that the Kremlin's official news release after the 'surprise' OPEC+ output cut should be read. "Both sides praised the level of cooperation within the OPEC+, which makes it possible to take timely and efficient steps in order to maintain the balance of oil demand and supply." This is what used to pass for humour in Putin's KGB circles.

By Simon Watkins for Oilprice.com

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Simon Watkins

Simon Watkins is a former senior FX trader and salesman, financial journalist, and best-selling author. He was Head of Forex Institutional Sales and Trading for… More