Oil Price Drop Imminent If Moscow Says “No” To Extension

As the November 30 meeting in Vienna of OPEC and its partners in the oil production cut deal nears, worry has returned among traders: one of the brokers of the deal might decide to walk out on the deal instead of participating in another extension.

We’re talking about Russia, the world’s top producer and exporter, who many believe played OPEC and specifically its leader, Saudi Arabia, by agreeing to a relatively minor production cut from its nearly record-high rate of production.

Reports emerged last week that Russia is considering a delay on the decision to extend the cut. That’s after Energy Minister Alexander Novak hinted more than once that from Moscow’s perspective, this decision is far from urgent. With a budget based on Brent at US$40, Russia is indeed in a sweet spot compared with its partners in the deal: it can remain in the black at any price above US$40.

But there may be another reason for Moscow deciding to opt out of the extension. Lower oil prices could actually be more beneficial for the Russian economy. Macro-Advisory analyst Chris Weafer lists six ways in which lower oil prices would be better for Russia, and all of these make sense, counterintuitive as this line of argument might seem at first glance.

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For starters, the higher the price of oil, the greater the risk of another collapse down the road. The more oil costs, the more producers will invest in new production, possibly leading to a repeat of the 2014 collapse. Or prices could simply take a dive once the OPEC deal ends, which it must at some point.

A higher oil price would also likely compromise a budget reform currently in the works, which aims to rein in spending. More importantly, Russia’s economic diversification efforts may well be compromised if oil prices remain higher—a point we’ve made repeatedly on Oilprice, not just with respect to Russia but to all oil-dependent economies.

According to Weafer, however, renewable energy does not play a large part in this diversification. He says that stifling investments in renewable energy is one more reason for Moscow to want oil prices to fall: the higher oil prices are, the more attractive renewable energy becomes.

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Yet another reason is that Moscow prefers to keep the ruble cheaper as this stimulates exports, curbs imports, and boosts competitiveness. Traditionally, the Russian currency has followed Brent’s moves closely, but this link has now been severed thanks to a fiscal rule mechanism employed by the Russian Finance Ministry that involves converting more rubles into forex as tax on the oil industry rises, pressuring the local currency. If, however, Brent goes high enough, there may be a spike in speculative interest in rubles, which will cause the currency to rise, too.

All of these reasons make perfect sense for Russia. They are unlikely to be praised by its partners in the deal, however. Right now, according to analysts, OPEC’s meeting on November 30 and the deal extension expected to result from it is the single most important tailwind for oil prices, as the effect of tensions in the Middle East begins to subside in the absence of any escalation. In this context, the consequences of Russia pulling out of an extension beyond March 2018 are all too easy to guess.

By Irina Slav for Oilprice.com

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