Could cracks be forming in the bromance between Saudi Arabia and Russia over oil production quotas? According to one analyst, the answer could be - yes. The background for one of the biggest structural changes in global markets in recent history dates back only a few years when OPEC defacto leader Saudi Arabia mismanaged its decades-old role as global oil markets swing producer and actually ramped up production in late 2014 in response to a then saturated oil market.
The Saudi thinking at the time was straight forward. Since US shale oil producers had caused the supply overhang and since shale oil producers at the time had a relatively high oil production break-even point, the Saudis would simply turn on the oil production spigots to flood markets even more, driving prices down to points below shale producers’ break-even points, thus driving them out of business. Though the Saudis have always denied this line of reasoning, it’s apparent from their actions at the time that this was their agenda, as well as jealously protecting oil market share, especially in Europe and Asia.
Yet, that plan backfired and with OECD oil inventory levels spiking with the next year plus, prices dipped below the $30 per barrel price point by January 2016. In response, Riyadh had to not only backpedal, it also had to seek help outside of OPEC, and turn to non-OPEC members, particularly Russia, to forge the first OPEC+ deal to return markets to a semblance of equilibrium and support prices.
Fast forward just a few years and the second OPEC+ deal was reached in December and implemented in January for a period of six months with a review period to be held in April. However, this time Russia is reportedly not trimming production per terms of the new OPEC+ deal, leaving most of the heavy lifting to Saudi Arabia. Related: New Sanctions Threat Puts Russian Energy Sector On Edge
Saudi Arabia's Energy Minister Khalid al-Falih, told CNBC in January that Moscow had moved "slower than I'd like. In response, Russian energy minster Alexander Novak, who reportedly is on al-Falih's smart phone speed dial list, responded in kind. In early February, Novak said Russia was "completely fulfilling its obligations in line with earlier announced plans to gradually cut production by May this year."
The numbers don’t lie
However, the numbers come down against Russia’s claims that it is shouldering its part of the new deal. Per terms of the deal, OPEC+ members agreed to cut supply by 1.2 million barrels per day(bpd). Saudi Arabia agreed to make up for most of the cut among OPEC members and has also confirmed it will drop its crude oil production by a further 400,000 bpd to 9.8 million bpd in March. If that output cut is reached, it would mean that since December (one month before implementation of the deal), Saudi Arabia has become responsible for 70 percent of the total OPEC+ target.
Russia, for its part, was supposed to account for the greater share of non-OPEC cuts, but from October to the beginning of February had only decreased output by 47,000 bpd. Related: The World’s Largest Battery To Power The Permian
Now, Torbjorn Soltvedt, principal MENA politics analyst at Verisk Maplecroft, is weighing in on the development, according to a CNBC report. In a note Tuesday, he wrote that any end to Russian-Saudi coordination would likely add significant downward pressure on prices. "Although our base case is still that Riyadh and Moscow find a compromise to extend the agreement, the pact is now looking more fragile than ever," said Soltvedt. He added that to save the pact he expected Saudi Arabia may even have to settle for "low levels of (Russian) compliance to save the pact."
However, going forward, the biggest risk is not the still freshly minted bromance between Russian President Vladimir Putin and Saudi Crown Prince Mohammed bin Salman, but for global oil markets. If the OPEC+ group unravels and Russia once again turns in the oil production spigots, it would force Saudi Arabia into a weakened state, similar to where it was in early 2016, when it had to turn to non-OPEC members, and Russia, for help soaking up oil supply overhang. This dynamic, along with U.S. oil production which is poised to pass a once imaginable 12 million bpd, would not only inflate global oil inventory levels, but with significant downward pressure on prices, both Brent and West Texas Intermediate.
Likewise, a deterioration of Saudi-Russian cooperation in oil markets would also impact the two sides geopolitical interests, especially since Riyadh and Moscow are on opposite sides in the ongoing Syrian Civil War, and more importantly, on opposite sides in how to deal with Iran’s regional hegemony ambitions, as well as it ballistic missile and nuclear development ambitions.
By Tim Daiss for Oilprice.com
More Top Reads From Oilprice.com:
- An Underestimated Niche In Oil & Gas
- The End-Game For Libya’s Oil Crescent
- The Ultimate Tool To Prop Up Oil Prices
One benefit is that Saudi Arabia and Russia between them account for 26% and 25% of global oil production and exports respectively. This enables them to play a pivotal role in stabilizing the global oil market and prices.
Another benefit is that through their cooperation, they managed to engineer the two production cut agreements with Russia playing a major role in persuading Iran to agree to the agreements.
A third benefit is that for Saudi Arabia, the cooperation with Russia acts as a counterbalance to the United States and any pressure it might exert on the Saudis.
A fourth benefit is that Russia could use its influence with Iran and its friendship with Saudi Arabia to reduce tension between the two countries and may be help open negotiations between them at some point in the future. That is exactly the opposite of what the United States and Israel are doing.
Still, the oil objectives of both countries particularly over oil prices are not the same. Russia through its diversification programme since the 2014 oil crash can now live with an oil price of $40 a barrel or less while Saudi Arabia needs an oil price far above %80 to balance its budget.
And while Saudi Arabia can cut its production and exports fairly quickly to abide by OPEC+ production cut agreement, Russia has to go slowly since the bulk of its production is made by many Russian companies in which the State has some stake. These companies have invested heavily over the years in the Arctic to boost Russia’s oil production and would therefore like a quick recoup of their investments, hence their opposition to production cuts. Russia will continue to adhere to the OPEC+ cuts.
Still, Saudi Arabia and Russia are diametrically opposed to each other ideologically and politically. Russia supported by China is trying to undermine the current unipolar role currently enjoyed by the United States whist Saudi Arabia will do anything to remain in the United States’ good books. So such a partnership many never be one for the long term.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London
Another aspect of the Saudi/Russian working cooperation is the USD reserve currency status. It is to the Saudi benefit at the moment to keep the USD as the settlement of accounts currency for oil trade. As SA has leverage over the US while keeping the USD as its primary go to currency.
Meanwhile Russia along with other countries such as India, Iran and PROC have engineered bilateral currency swap and settlement of accounts agreements. It is not to the benefit of these countries to use the USD because of arbitrage loss on their own currency when using the USD to settle oil accounts.