The Fuse

Saudi Arabia: Gambit, or Pivot Heading into this Week’s OPEC Meeting?

by Leslie Hayward | November 29, 2016

It wouldn’t be an OPEC meeting without some unexpected plot twists in the days leading up to group’s ministerial meeting, and this week is no exception. OPEC, and in particular Saudi Arabia, have put their credibility on the line following a tumultuous year, which included the last minute collapse of a freeze agreement in Doha, followed by another anticlimactic meeting last June that concluded without so much as a production target for the second time. Renewed speculation over the “death of OPEC” abounded.

But the cartel was able to regain control over the narrative at the extraordinary Algiers meeting in September when many hours of deliberation resulted in a nominal agreement to restore a collective production ceiling at 32.5-33 million barrels per day (mbd)—the first OPEC cut in eight years. Uncertainty loomed about how such a cut would be achieved, given the fact that Libya and Nigeria’s production has sputtered from internal strife, Iraq and Iran have struggled to produce credible production numbers, confusion over how much of its own production Saudi Arabia would be willing to sacrifice, if Russian participation is necessary, and the possibility of a rebound from U.S. shale, among other issues.

Markets rallied at the news with prices surging back above $50 per barrel, but quickly receded as the reality of these unanswered questions set in. Coming into this week’s meeting, OPEC’s member states know that after spending almost a full year using the possibility of a cut or freeze to twist market sentiment and buoy prices that it’s now or never—failure to follow through with the promised agreement at this week’s meeting will likely cause a dramatic selloff in the short term, and shatter remaining credibility in the long term.

In an effort to manage these expectations, Saudi Arabia kicked off the week by canceling a meeting with Russia and other non-OPEC producers scheduled for Monday, November 28, and Energy Minister Khalid al-Falih reverted to highly measured language and argued that the market is rebalancing itself on Sunday. Speaking to reporters from Aramco headquarters, al-Falih stated, “We expect the level of demand to be encouraging in 2017, and the market will reach balance in 2017 even if there is no intervention by OPEC. But OPEC intervention aims to expedite this balance and the market recovery at a faster pace.” He added, “Regardless of Saudi and its market share, I think if we look at it as an indication of the health and recovery of the oil markets, it is a positive sign that makes us optimistic about the market recovery. I don’t think that we have one path only in OPEC meetings, which is cutting production—I think maintaining production at current levels is justifiable, taking into consideration the recovery of consumption and growth in developing markets and the United States.”

Saudi Arabia’s moves are being read two ways this week in Vienna—as either a pivot to signal a true willingness to walk away without a deal, suggesting a return to policy from 2014-2015, or as a gambit to increase pressure on other OPEC members, particularly Iraq and Iran, to fall in line. Given the likelihood of a price plunge if the deal falls through, it’s more likely the latter. On Wednesday, look for signs of a credible deal in the form of clear individual country quotas, but real proof that countries are following through with their committments will take weeks or months to materialize in the export data.

In response to the weekend’s developments, the ministers from Venezuela and Algeria flew to Moscow in a presumed effort to get the Kremlin on board with a deal that includes non-OPEC producers.

State of play with Russia

Of course, OPEC’s moves don’t occur in a vacuum, and other global events have taken place in the two months since the Algiers meeting. One outstanding question is how the unexpected election of Donald Trump as President of the United States will impact global energy markets. In a recent Capitol Crude podcast, Platts explored questions surrounding the possibility that Trump will lift sanctions on Russia’s energy sector. The sanctions, which were put in place following Russia’s 2014 invasion of Ukraine’s Crimean Peninsula, were designed to sever Russia’s access to advanced oil extraction technologies. They caused companies including ExxonMobil to lose up to $1 billion invested in a partnership with Russia’s Rosneft to develop the country’s shale, Arctic, and deepwater oil resources.

The Trump win could reverse that. According to Rosemary Griffin, editor for Platts based in Moscow, not only did Putin’s regime see a Clinton win as likely, she was viewed as a potential threat to Russian interests, and as seeking to augment sanctions in response to Russia’s actions in Syria.

In that context, Trump’s victory not only eases fears of heightened sanctions but also opens the door for access to extraction technologies that will enable it to develop frontier oil resources.

It’s unclear what, if anything, Trump would want from Russia in return for removing U.S. sanctions on Russia’s oil sector. But if Moscow sees an opportunity to develop new resources, combined with the possibility of higher prices if OPEC shoulders the burden of output cuts, might it be less willing to agree to a production freeze?

Joe McMonigle, President of the Abraham Group, sees other barriers to Russian participation. “I see an easing of the U.S. sanctions against Russia as fairly likely. Is the upside to oil production likely to change Russia’s calculations as it engages in talks with OPEC? I don’t think so. But I do think there’s a real issue with the logistics of implementing a production cut in Russia given the nature of its oil industry. Their production is far flung, in remote regions with hostile climates, and is operated by private companies in partnership with the IOCs—it’s not straightforward like it is in Saudi Arabia.”

Russia is currently producing a record 11.2 million barrels per day of oil, and thus far current sanctions have not diminished its energy production. The sanctions apply to use of advanced drilling technology developed largely by American companies and the partnerships which would allow these technologies to be applied to Russian geology. The sanctions have also coincided with the extended period of low oil prices which deter investment in expensive shale, Arctic, and deepwater oil.