Uncertainties mark Russia-OPEC alliance

Russia will support temporary production cuts to bolster prices but if its economy worsens this year, Putin may institute a “Russia first” policy.
Sunday 13/01/2019
Tactical alliance. Russian Minister of Energy Alexander Novak (L), Saudi Minister of Energy, Industry and Mineral Resources Khalid al-Falih (C) and Emirati Minister of Energy Suhail Mohamed Al Mazrouei attend a news conference in Vienna, December 7. (AP)
Tactical alliance. Russian Minister of Energy Alexander Novak (L), Saudi Minister of Energy, Industry and Mineral Resources Khalid al-Falih (C) and Emirati Minister of Energy Suhail Mohamed Al Mazrouei attend a news conference in Vienna, December 7. (AP)

Russian Energy Minister Alexander Novak floated the concept of a new organisation based on the OPEC+ format. It was to include the 15 members of OPEC and Russia and it would have started its work — boosting the market — on January 1.

That date has passed and the Russians now seem to think OPEC+ is unnecessary.

Cooperation to stabilise the market was clearly in the interest of major producers. The price of oil gyrated wildly in 2018, rising to a 4-year high in October before dropping more than $30 a barrel by the end of the year.

The swings played havoc with OPEC members’ budgets, particularly Saudi Arabia, the group’s top producer. Saudi oil exports account for almost 90% of revenue and more than 40% of its GDP.

On December 27, Novak said an “official” alliance “would only create headaches for all concerned.” In an oblique reference to the effectiveness of US sanctions, imposed on Russia since 2014, Novak added that such an arrangement would expose non-OPEC members of the alliance to potential US sanctions. OPEC members Iran and Venezuela are subject to US sanctions, which have had noticeable negative effects on their economies.

Seeking to downplay his announcement, Novak added: “There is a consensus that there will be no such organisation. That’s because it requires additional bureaucratic brouhaha in relation to financing and cartel concerns with the US side.”

Instead, Moscow proposed a special cooperation mechanism, which would allow oil producers to convene, discuss and adopt memorandums or joint resolutions.

Given that Russia earned nearly $120 billion in additional revenue in 2018 because of the OPEC+ pact to cut production, the proposed mechanism left OPEC members suspicious of Russia’s intentions.

That said, OPEC and Russia have been broadly coordinating policy since the end of 2016. On December 7, during a meeting in Vienna, the OPEC+ group agreed to cut production by 1.2 million barrels per day (bpd).

Under the agreement, OPEC would make two-thirds of the cut while Russia and other top non-OPEC oil producers would reduce production by 400,000 bpd. The cuts were to begin January 1 and extend for six months, with a review set for April. Iran received an exemption from the reductions because of renewed US sanctions.

A significant impetus for the December meeting was the fall in global oil prices by more than 20% the previous month. The OPEC meeting convened in Vienna despite weeks of pressure from US President Donald Trump to keep crude oil prices low.

An important question remains: Will OPEC+ remain a pragmatic, if temporary, tactical alliance between OPEC and the Russian Federation or will it deepen into something more permanent?

As for the future, many OPEC participants are infamous for cheating on quotas to generate as much quick cash as possible.

What makes the situation harder to predict is the administration in Washington, which is manifestly friendly to “big oil.” US domestic oil production has been surging due to fracking and is likely to expand as new export pipelines become operational.

However, while potential US oil exports may surge, they could suffer price stagnation or a decline in a saturated global market that shows signs of cooling. There may also be the effects of worsening US trade relations with Mexico and Canada, both major oil producers, and deteriorating US-China trade relations.

Virtually all OPEC members, as well as Russia, clearly want the highest possible price for oil but OPEC members have their own economic and political problems. Venezuela and Iran desperately need revenue from expanded output, no matter what the price. In contrast, Saudi Arabia needs a benchmark oil price of at least $80 per barrel to balance its budget.

Russia’s more diversified economy can live with oil at $40 per barrel. The dissonance within OPEC, with some of its members covertly and overtly ramping up production for maximum short-term gain, undercuts organisational solidarity. The solidarity is epitomised by Saudi Arabia, OPEC’s leading advocate of curbing short-term production for longer-term profits.

Accordingly, Russia, which can cope with a lower barrel price, will show unity with OPEC. Russia will support temporary production cuts to bolster prices but if its economy worsens this year, Russian President Vladimir Putin may institute a “Russia first” policy. At that point, Russia may not worry too much about the consequences for its new energy allies.

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