As OPEC extends deal, Saudi-Russia pact struggles to boost oil price
It was all about oil prices this week as OPEC and non-OPEC producers agreed to extend the production cut deal by nine months into 2018. Even though this was the widely expected scenario, the disappointment reflected in the price reaction appeared to be twofold, with cuts not being deepened and no new producers joining the agreement.
Nonetheless, it kept some optionality open for cuts being extended beyond the additional nine months, should prices decline.
Long story short: as oil held its biggest loss in three weeks following the meeting, Saudi Arabia’s Energy Minister said the cuts are working and stockpile reductions will accelerate in the third quarter, with inventories falling to the five-year average early next year.
Moreover, according to Russia’s Energy Minister Alexander Novak, producers have more tools to further support prices if needed.
Oil producers need to do more
The efforts of Saudi Arabia and Russia to extend their output restraint until March 2018 initially rallied crude oil prices, but dropped after more countries joined the deal in Vienna on May 25.
This indicates that oil producers either need to do more to stem the glut or be prepared for a further slide in prices in due course.
After crossing the $55 per barrel mark in early April, oil prices slid to roughly $44 in early May, the lowest in more than a year. The Saudi-Russia announcement pushed the price up to $54 a barrel by May20, but it lowered and hovered around $50 during the last week of May.
Oil prices have halved over the last three years, leading to a phenomenal drop in revenues for oil producers. But the current prices are far better than the $30 a barrel that reigned in early 2016, the lowest in 12 years.
In mid-May, the world’s largest producers announced that they had “reached an understanding” to prolong a deal first reached in November 2016 to hold back about 1.8 million barrels of crude a day. That agreement between the Organisation of Petroleum Exporting Countries (OPEC), led by Saudi Arabia, and non-OPEC countries, led by Russia, had also boosted prices.
Last year’s agreement among OPEC members was the first sign of such cooperation in a decade. The OPEC-non-OPEC deal was a first in about 15 years. The last time Saudi Arabia and Russia cooperated over the oil production issue was amid global economic uncertainty following the Asian financial crisis, dot-com bubble and US economic recession at the turn of the century.
On the flip side, however, relatively higher prices led to an output increase by shale producers in the US, which was and is still not a party to the deal. This failed to curtail the glut in the energy market and limited the impact of production cuts for the other oil producers.
With reports of US production rising approximately ten per cent since mid-2016, some experts had argued that Saudi Arabia and Russia would be disinclined to extend their ‘underproduction’ deal.
But the Saudi-Russia proposal was endorsed for nine months by other producers, forcing prices down considerably.
Extension period is optimum
Saudi Energy Minister Khalid Al-Falih said: “We considered various scenarios, from six to nine to 12 months, and we even considered options for a higher cut. But all indications discovered that a nine-month extension is the optimum.”
The minister said he did not “worry about the knee jerk reactions of the market”. Instead, he claimed the group was focusing on market fundamentals and reducing oil stocks to below their five-year average.
“Shale is an important variable but we do not believe it is going to significantly derail or affect what we are doing. The market is big enough to absorb the expected increased production in shale in 2017,” he added.
However, industry experts claimed that the ability of the deal to increase prices by curtailing production will certainly be influenced by the volume and pace of US shale oil production.
Since “vigilance is the buzzword of the day,” the monitoring committee is scheduled to meet every two months to assess the situation and take necessary steps to adjust the policy. OPEC and non-OPEC members will meet again at the end of November to review their decisions.
Saudi Arabia hopeful for a price hike
Both Saudi Arabia and Russia are hopeful about a price hike in the medium to longer run. This optimism emerges more from necessity than market realities. Higher oil prices and consequent increase in revenues would help the two countries tackle their domestic economic and social problems better, which is key to political stability.
While presidential elections are due in Russia in March 2018, Saudi Arabia has resorted to austerity measures and even borrowed money from foreign investors to overcome budget shortfalls. Failure to make adequate alternative arrangements has led to unrest in some oil-producing countries like Venezuela and Nigeria, among others.
At another level, Saudi-Russia cooperation in the realm of oil also lends hope for better teamwork in the regional political arena, where the two countries are transfixed on opposite poles.
First, it is interesting that the Saudi-Russia oil deal talks occurred amid US President Donald Trump’s visit to the region. This means that while Riyadh seeks ways of positively recalibrating its ties with Washington, it is continuing to engage with Moscow, which made a huge comeback to the region during the last few years.
Oil deal to build confidence
Second, given the influence of the two countries in Syria, the oil deal helps as a confidence-building measure to coordinate and implement a relatively common agenda in the war-torn country that could yield beneficial results for all the countries involved in the conflict.
Third, given Russia’s proximity to Iran and Saudi Arabia’s friction with the Islamic Republic, the deal serves as a channel for Riyadh to influence Moscow to moderate its ties with Tehran. This could ultimately help the Kingdom and the region check Iran’s hegemony.
Thus, while the Saudi-Russia deal is economic in nature, it is politically potent as well. This makes it tough to predict how one factor could impact the other and how this would ultimately influence oil prices.