The Fuse

Russia, Saudi, and the Makings of SUPEROPEC

January 24, 2017

Guest Post by Matthew M. Reed | @matthewmreed

Matthew M. Reed is Vice President of Foreign Reports, Inc., a Washington, DC-based consulting firm focused on oil and politics in the Middle East.

2016 was an historic year for Saudi-Russian relations and each country’s respective oil sector. Both nations reached production levels not seen in decades. Saudi Arabia, the natural leader of OPEC by virtue of volume, climbed to 10.7 million barrels a day (b/d), while Russia, a non-OPEC oil superpower, surged to 11.2 million b/d late in 2016. Yet high volumes weren’t enough to relieve the pain of low oil prices. Saudi Arabia launched a multi-year austerity program last year, the likes of which has never been seen before, and the Russian economy shrank thanks to low prices and sanctions.

As of mid-2016 there was no relief in sight. An emergency meeting held in Doha in April imploded at the last minute. OPEC’s bi-annual meeting in June also fizzled without reaching a supply pact that would cut production and buoy prices. Throughout much of the year, prices languished in the $40-50 range. In reality, they were only that high because expectations were raised again and again for a deal that would restrain supply.

In November, Riyadh and Moscow effectively brought together what we might call a “Super OPEC” or “OPEC Plus”. Together they cajoled and convinced 22 other producers to do what OPEC could not: Cut enough to make a difference and fairly spread out the pain.

That elusive deal was finally nailed down on November 30 and completed on December 10 after months of close cooperation between Riyadh and Moscow. Effective January 1, 2017, it aims to take some 1.8 million b/d off the market in the first half of this year. The 24 nations which signed the supply pact (13 OPEC/11 non-OPEC) expect cuts and rising global demand to balance the market some time this year. The deal could be extended another six months if it takes longer. No one knows exactly how long it will take and no one expects 100 percent compliance. But at the very least, Riyadh and Moscow negotiated a ceasefire among producers which has the potential to end a two-year period of runaway production, cheap oil and massive stock builds.

It’s not too early to say the deal is an historic achievement—at least on paper. It also marks a major turning point for Saudi-Russian relations. And for oil markets the implications could be huge. In November, Riyadh and Moscow effectively brought together what we might call a “Super OPEC” or “OPEC Plus”. Together they cajoled and convinced 22 other producers to do what OPEC could not: Cut enough to make a difference and fairly spread out the pain.

Much has been made of Russia’s spotty track record when it comes to cutting oil production in coordination with OPEC. You can count former Saudi Oil Minister Ali Naimi among the skeptics. But there are reasons to believe this time is different. Throughout the second half of 2016, the Russians and Saudis made a coordinated diplomatic push to get major producers and allies of theirs to commit to supply cuts. They put their own credibility on the line to leverage relationships.

What’s more, if you talk to OPEC officials, they’ll tell you the Russians impressed them early on with their seriousness and attention to detail. This time the Russians were interested in specifics and active behind-the-scenes, whereas before they were resistant if not outright dismissive. (This much was obvious if you followed Russian-language trade press throughout 2016.) OPEC officials give Russian Energy Minister Alexander Novak high marks for his professionalism. They were very encouraged when President Vladimir Putin took a hands-on roll pushing for Russian oil companies to cut back production.

Maybe most telling of all was the frequency of contacts between Russian and Saudi leaders in the second half of 2016, when a supply pact was anything but a done deal. Putin and Deputy Crown Prince Mohammed bin Salman of Saudi Arabia met on the sidelines of the G20 summit in Hangzhou, China in September. The two leaders signaled then that oil was their top priority.

It’s unclear just how closely Novak and Falih are coordinating but their public remarks regularly and conspicuously overlap.

To emphasize the point, the Russian energy minister and his Saudi counterpart, Khalid al-Falih, signed a joint declaration to stabilize oil markets on September 5. “In effect we are today opening a new era in our cooperation, our energy cooperation is progressing to deeper and closer cooperation, to strategic partnership,” Russia’s Novak said at the time. “It is an historic moment in my view.” Later that month, OPEC committed to the Algiers accord, which served as the blueprint for the November deal reached in Vienna.

Going into Vienna the Saudis were able to bring the usual suspects on board—the GCC producers, among others—and the Russians ultimately convinced the Iranians to freeze and some ex-Soviet producers to cut modestly. The Saudis agreed to the most severe cuts: 486 thousand b/d, which they’ve already surpassed. The Russians agreed to gradually cut production by 300 thousand b/d in the first half of 2017. They’re ahead of schedule.

Today the energy ministers of both countries are doing their best to manage market sentiment with reinforcing statements. It’s unclear just how closely Novak and Falih are coordinating but their public remarks regularly and conspicuously overlap. They also seem timed to prevent oil prices from backsliding whenever headlines reflect doubts about the OPEC/non-OPEC deal.

Going forward, it seems the Saudis and the greater GCC are ready and willing to do business with Russia even if their visions for the Middle East don’t align.

The relationship between Moscow and Riyadh comes with baggage old and new. Both sides back different factions in Syria, for example—but the price of oil is too important not to coordinate. Going forward, it seems the Saudis and the greater GCC are ready and willing to do business with Russia even if their visions for the Middle East don’t align. Qatar, another Arab energy powerhouse that opposes Russia’s intervention in Syria on behalf of the Assad regime, acquired a multi-billion-dollar stake in Rosneft, Russia’s top oil producer last month. If we use Syria as a yardstick, there are no insurmountable obstacles for Russian-GCC relations.

Echoing Novak’s remarks about the necessity and utility of a “strategic partnership,” Falih recently said that the OPEC/non-OPEC deal represented the start of a new era. “We at OPEC aim to optimize our relationship with Russia for the long term,” he told Reuters on January 19. “A quick fix is not a big objective. We want this to be a lasting partnership,” which will of course “evolve over time.”

We’ll have to wait and see how it evolves—and how U.S. shale producers respond—but OPEC can hardly contain its excitement. Look no further than the Organization’s latest bulletin, which ended with an exclamation point of all things: “The OPEC and non-OPEC producers that signed the Declaration [to cut/freeze oil production] now need to show the global community that they can work together and that together they can make a difference. This is about unity, it is about solidarity and it is about personal sacrifice for the eventual general good of all!”

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