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Abu Dhabi, UAESunday 23 September 2018

Putin election win raises questions about future of oil production pact

Cooperation between Russia and Opec has reaped dividends for global oil market

President Vladimir Putin walks out of a voting booth at a polling station during Russia's presidential election in Moscow. Yuri Kadobnov / AFP
President Vladimir Putin walks out of a voting booth at a polling station during Russia's presidential election in Moscow. Yuri Kadobnov / AFP

Results coming in late on Sunday unsurprisingly confirmed that Vladimir Putin will serve a fourth term as Russia’s president. His election win gives him a new-found position of strength to shape Russia’s foreign policy agenda; but crucially for the Arabian Gulf, it also raises key questions about the fate of the current Opec and non-Opec production agreement, with implications for both parties if the pact is not renewed or at least other alternative market stabilisation mechanisms are not put in place in 2019.

During his long tenure as Russia’s effective ruler President Putin has sought to reverse the country’s economic and political decline by rebuilding its military power. More recently, he has been instrumental in propping up global oil prices in partnership with Opec (and particularly Saudi Arabia), creating a mutually beneficial energy nexus with Arabian Gulf oil producers.

For such producers, the pact with Russia and other non-Opec producers in late-2016 to curb production to prop up oil prices established a mutually beneficial economic relationship, at a time when both sides desperately needed it; the fall of oil prices to under $30 per barrel in early 2016 put a massive strain on oil economies, which saw foreign exchange rates depleted, with austerity measures having to be introduced.

The road to the seemingly successful production deal of late 2016 was not an easy one; observers doubted it would succeed, given the geopolitical differences and the different operating frameworks of national oil companies and partly privatised national oil companies involved.

There is now much speculation on Russia’s next move ahead of the production deal’s expiry at the end of the year, and whether President Putin will be tempted to continue with the pact in 2019, opt out, or agree to a new form of mechanism to support oil prices.

The period from November 2014 to late 2016 was a difficult one for Opec members, with states divided on whether to freeze production or actually implement cuts, with uncertainty over whether other major oil producers would join such initiatives.

As part of its now famous market share strategy adopted in November 2014, Saudi Arabia increased oil production in March 2015 to its highest level in at least 12 years. The key message from Saudi Arabia’s then Oil Minister Ali Al Naimi was that Opec would not cut production without cooperation from non- Opec producers, notably Russia.

There was widespread distrust of Russia among Saudi Arabia and its Gulf allies; it seems the country had pledged to trim production by 300,000 barrels per day in 2008, only for such cuts to never materialise. Hence the unambiguous Saudi stance: the kingdom would only cut if other Non OPEC members do so.

Saudi Arabia’s stance from 2014-16 initially seemed logical, in that the country had waited for years to build a dominant production market share, and was understandably reluctant to give it up in the face of rising US shale production. In hindsight however, such a stance did not take into account the remarkable capacity for US shale producers to move quickly and act as “swing producers”, a role Opec had always amongst conventional oil producers.

The shock of seeing oil prices fall below $30 per barrel in January 2016 focused minds, and a new strategy had to be considered, including painful compromises by Saudi Arabia in allowing Iran to be excluded from any formal production cuts.

This total production freeze on all Opec and non-Opec producers, which had included Iran in earlier discussions, had been a stumbling block for a number of reasons. Notably, there was no verification process in place to monitor who was actually freezing and complying, with Russia insisting that Opec implement such a mechanism before they agree to join in any freeze or production agreement.

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Sometimes it takes two strong leaders to look beyond past issues and chart a new course of mutual interest. Such a course began to take shape in September 2016, with the signing of an agreement in China between Saudi Arabia and Russia to cooperate in world oil markets. Such an agreement came about following a very friendly meeting between President Putin and the then Deputy Crown Prince Mohammed bin Salman, with Putin lavishing praise on the Prince as “someone who is a reliable partner with whom you can reach agreement and can be certain those agreements can be honoured”.

The Saudi Deputy Crown Prince reciprocated, stating that global oil stability was “impossible without the cooperation of Russia and KSA”. While no specific output agreement was reached at the time, all talk at reviving another freeze was now discarded; both Iraq and Iran had made it clear they would not go along with such a freeze, with Iraq announcing a large increase in production by another 300,000 – 400,000 barrels per day. Iran meanwhile insisted raising its market share was a national and sovereign right.

The new Saudi energy policy seemed to acknowledge this impasse, and concluded that there were “two type of freezes”: an ‘official’ freeze and a practical one; the latter became of paramount importance, with a practical freeze involving countries producing at their capacity, but with room for increases limited in the short term, with few Opec producers having true spare capacity, especially Iran, which again in hindsight has been borne by events.

A ‘freeze’ basically signifies the fact that supply and demand are in balance and that Opec and others do not have to intervene in a radical manner, and as such, there was no need to cut back on production. But given the fact that the market has still some way to go before a true balancing takes place between supply and demand, the only viable option goes back to some sort of production cuts by both Russia and Saudi Arabia to underpin prices at above $50-$55 levels.

Following the successful Algiers OPEC meeting in September 2016, the Russians decided that the time was right to join the agreed OPEC production cuts, and committed to its own 300,000 bpd cutback from 2017. In return, it was granted the chairmanship of the Non -OPEC monitoring committee to ensure compliance of this group . The ‘excellent’ relationship between Russian Energy Minister Alexander Novak and Saudi Arabia’s energy minister Khalid Falih has added to this successful pact.

Looking forward, markets might still be taken by surprise if the Opec and non-Opec pact is not renewed either in its current form beyond 2018, or more likely under a new, longer-term mechanism that allows for production increases or cut backs depending upon market conditions.

The key is that Opec and non-Opec countries have both learned from this coordinated approach that it is far better than the previous mutually-antagonistic policy, which was on the verge of splitting Opec apart and making it an irrelevant organisation.

President Putin has to weigh the long term benefits of further deepening the existing Russian – Saudi energy alliance, in the face of increased Western sanctions and pressure, as well as calls from his own partly privatised national oil company executives that production cuts are harming their investors. It is also something that Saudi Aramco will have to consider post its long-awaited IPO, on how its future oil production policy will be driven by both sovereign and market forces.

Dr Mohamed Ramady is an energy economist and geopolitical expert on the GCC, and former professor at King Fahd University of Petroleum and Minerals, Dhahran, Saudi Arabia, and co author of 'OPEC in a Post Shale world – where to next?’. His latest book is ‘Saudi Aramco 2030: Post IPO challenges'.

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