(Bloomberg) — The most powerful partnership in the global oil market, which rescued the industry from a deep slump, faces its toughest test yet.
Crude has collapsed by more than 30 per cent and Saudi Arabia is urging Russia to collaborate in cutting production again. Their alliance successfully revived markets two years ago, but it’s unclear if Moscow is on board this time. Russia’s government is feeling less pain than kingdom from falling prices, while its companies are enjoying near-record output and cash flow.
“Whether or not the Russians have the appetite to cut back oil production, we have to wait and see,” said Rainer Seele, chief executive officer of OMV AG, an Austrian company with significant investments in Russia.
At stake is not just the price of oil, but the political bond between President Vladimir Putin and Crown Prince Mohammed Bin Salman. Moscow will have to weigh bread and butter economic issues against the desire to keep expanding its influence in the Middle East.
It’s two years since Saudi Arabia and Russia first set aside decades of commercial rivalry and ideological differences to forge a 25-nation alliance of oil producers, now commonly called OPEC+. Through 18 months of joint production cuts starting in January 2017, the group cleared an oil glut and boosted prices, ending the industry’s worst downturn in a generation.
In June, with the cuts having done their job and U.S. sanctions threatening to remove a big chunk of Iranian oil from the market, they changed course. Saudi Energy Minister Khalid Al-Falih and his Russian counterpart Alexander Novak guided their allies to an agreement for a sizable production increase.
Their partnership is under strain today because that decision backfired. As Moscow and Riyadh opened the taps, U.S. shale drillers also pushed their production to unprecedented levels. Meanwhile, Trump’s threat to send Iran’s exports to zero proved to be bluster and his administration unexpectedly granted sanctions waivers to buyers.
Since October, Brent crude futures have plunged $26 from a four-year high. The international benchmark is now trading at about $60/bbl, below the level required to balance the budgets of most members of the Organization of Petroleum Exporting Countries.
Trump remains a wild card for the OPEC+ alliance. He’s still putting pressure on the Saudis to help consumers by pushing prices even lower. Facing a growing threat of antitrust legislation and other penalties after the murder of journalist Jamal Khashoggi, the kingdom may choose to do the president’s bidding and keep the taps open.
For now at least, the Saudis do seem to favour higher prices. OPEC+ needs to cut supplies by at least one million barrels a day, Al-Falih said in Abu Dhabi on Nov. 12. The kingdom’s output has reached a record 11.2 million bbls/d this month, according to people familiar with the matter, but in December daily shipments will drop by about 500,000 barrels, the minister said.
Novak sounds less convinced. Producers “need to see how the situation develops in November and early December” before deciding whether to intervene, he said in Moscow on Nov. 19. Prices have since fallen below the comfortable range of $65 to $75 advocated by Putin in early October.
The Russian president may meet the Saudi crown prince and discuss oil markets at the Group of 20 summit in Buenos Aires this week, according to the Kremlin. If they sketch out a deal, it would fall to Al-Falih and Novak to finalize it when OPEC+ gathers in Vienna from Dec. 6 to 7.
“Some issues limit further output co-ordination between Russia and OPEC,” said Ildar Davletshin, energy analyst at Wood & Co. Financial Services AS. “High oil prices are not as important for Russia as they used to be — strong oil may even become a problem.”
Price gains earlier this year were a mixed blessing for Russia. The government will get about 45 per cent of its budget revenue from oil and gas this year, but can cover spending next year even if its own crude benchmark, Urals, falls to $40. For the broader population, the jump in domestic fuel prices stoked inflation, squeezed struggling consumers and sparked scattered protests by drivers.
Russian oil producers such as Rosneft PJSC haven’t voiced much enthusiasm for cutting again. The way the country’s tax system is structured means a combination of higher output and lower crude prices helps producers retain more profits. Further supply restraints would also delay plans to start new projects.
On the flip-side, there are many political reasons why Putin could renew his Saudi alliance. From Syria to the Kurdish region of Iraq, Russia has expanded its influence in the Middle East at the expense of western powers in recent years. The pact with an established Washington ally like the House of Saud strengthens the Kremlin’s position.
“If you’re Vladimir Putin, you also have to think about what are you going to gain in terms of soft power,” said Helima Croft, chief commodities strategist at RBC Capital Markets LLC in New York. “And the ancillary economic benefits you get from sticking with Riyadh, like weapons deals.”
Putin said last month that, given the positive results of Russian co-operation with OPEC, the alliance should continue.
If Saudi Arabia does propose cuts in Vienna, Davletshin and other analysts expect Russia to ultimately find the political rewards irresistible, even if the economic benefits are debatable. Out of 36 analysts and traders surveyed by Bloomberg , 31 predicted OPEC+ would agree to reduce output, with an average estimate of 1.1 million bbls/d.
“I think this relationship could be built to last,” said RBC’s Croft. “It always goes down to the wire, they keep us guessing — and the Russians come through for the Saudis in the end.”
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