The Fuse

Saudi Arabia and Russia Deepen Energy Ties, Set to Continue Oil Market ‘Cooperation’

by Nick Cunningham | October 06, 2017

This week, Saudi Arabia’s King Salman became the first Saudi monarch to visit Russia, deepening the growing relationship between world’s largest oil producers. The trip produced a number of deliverables, including preliminary agreements that involve Saudi investments in Russia’s largest oil drilling contractor as well as plans for a major petrochemical project in Saudi Arabia to be built by a Russian company.

The more significant development for the oil markets is the strengthening of ties between Moscow and Riyadh, bolstering the two countries’ cooperation through the OPEC/non-OPEC production cuts. The current warm relationship between the two countries suggests that their oil market coordination will persist. OPEC has said that it is working to “institutionalize” the increased cooperation between OPEC and non-OPEC oil producing states, reflecting how important the Saudi Arabia-Russia alliance is. The countries represented in the current agreement add up to approximately 58 percent of daily oil supply.

Energy deals

Saudi Arabia and Russia inked a raft of deals and an agreement to establish a $1 billion fund to invest in energy projects, but that could be “just the tip of the iceberg,” according to Helima Croft, Global Head of Commodity Strategy at RBC Capital Markets. Croft argues that the initial deals will likely pave the way for more joint ventures in the energy industry.

Saudi Arabia and Russia inked a raft of deals and an agreement to establish a $1 billion fund to invest in energy projects, but that could be “just the tip of the iceberg.”

Saudi Arabia is also considering a sizable investment in Eurasia Drilling Company, Russia’s largest oil drilling contractor, and it may also invest in Novatek’s proposed Arctic LNG project, which has the potential to bring new LNG export capacity online in the early part of the next decade. Gas produced from the LNG project, in theory, could ultimately fuel Saudi Arabia’s growing petrochemical industry.

The visit of King Salman also opened the door to a range of other agreements that could deepen the energy ties between the two colossal oil producers. Saudi Aramco signed a memorandum of understanding (MoU) with Russia’s Gazprom Neft to collaborate on drilling technologies, according to the FT. Also, Aramco signed another MoU with Russia’s petrochemical giant Sibur and the Russian Direct Investment Fund (RDIF) to explore cooperation on joint investments in petrochemical projects, including an initial agreement for a $1.1 billion investment for the construction a petrochemical complex in Saudi Arabia to be built by Sibur. The collection of deals are estimated to top $3 billion in value.

The foundation of a Saudi-Russian relationship

The oil production cuts agreed to in late November 2016 ushered in a new era of Saudi-Russian cooperation.

The oil production cuts agreed to in late November 2016 ushered in a new era of Saudi-Russian cooperation. From OPEC’s point of view, bringing Russia on board with output curbs made the deal substantially more effective. Besides Russia cutting production to take more barrels off of the market, the psychological impact of coordination among the two largest producers shifted sentiment in the market. Late last year, some OPEC members were skeptical of coordinated action, but the inclusion of Russia made the price of not participating in the cuts much higher for wary OPEC members. Russia’s contribution helped solidify the resolve of the cartel.

Compliance in the first quarter was a bit spotty, with Saudi Arabia cutting deeper than required in order to make up for rising output from exempted members. But more recently, laggards—such as Iraq—have made steeper cuts.

Russia’s commitment to the deal seemed tepid at first, but it now appears more convincing. After curbing output by only 100,000 b/d at the beginning of 2017, Russia dropped its production to 10.91 mbd in August, allowing the country’s compliance rate to exceed 100 percent. In fact, the non-OPEC coalition achieved a higher compliance rate than OPEC in August for the first time.

Strengthening of OPEC/non-OPEC alliance

While Riyadh and Moscow are looking for common ground on a range of issues, including the complex web of competing interests in the Syrian civil war, the blockade of Qatar, and the influence of Iran in the region, close relations between the two indicate a willingness to continue oil market management. Their deepening ties suggest the prospect of extending the production cuts beyond March 2018.

“Back in 2015, Russia said it had no intention of cooperating with Saudi Arabia but look at it now…it is like watching an OPEC ‘bromance,'” Helima Croft of RBC Capital Markets told CNBC. Now Russia is “essentially playing the role of OPEC co-president,” she added.

On October 4, Russian President Vladimir Putin said that his country would be willing to extend the cuts through the end of 2018. “Based on the realities in March 2018, we will make our decision, but I do not rule out that we may extend,” Putin said at the Russian Energy Week conference in Moscow on Wednesday. “If we speak about a possible extension, then of course, it should be at least until the end of 2018.”

Saudi Arabia appears to be on the same page. “In the kingdom, we have to keep all options open, President Putin agreed with us on this and expressed his readiness to extend until the end of 2018 if this is agreed, and if this is the best option,” Saudi Energy Minister Khalid al-Falih told Al Arabiya this week.

The Russian-Saudi energy relationship

Both countries have much to gain from this newfound friendship.

Both countries have much to gain from this newfound friendship. The willingness of Russia to continue to cooperate with OPEC offers a lot of upside without too much sacrifice. Russia has pledged to cut its output by only 300,000 b/d. The production level is not trivial, but also not a massive reduction, particularly in comparison to the Saudis, who said they’d cut by 486,000 b/d. Russia has taken advantage of higher oil prices by signing onto the deal, without having to cut production by a substantial amount. Oil prices have climbed as a result of the OPEC/non-OPEC agreement, and the Urals benchmark has seen its discount relative to Brent narrow this year, a boon for Russia.

For Russia, “price gains are more valuable than volume gains—how much can you really pump more from last year’s peak production level?” Dominic Schnider, head of commodities and Asia-Pacific currencies at UBS’s wealth-management unit, told Bloomberg in an interview. “We think they’re going to stick to the pact and over the coming months they are likely to extend it.”

Saudi Arabia and Russia successfully collaborating on manipulating fundamentals and lifting prices, if it continues, will likely have large ramifications for the global oil market in the future.

Saudi Arabia is concerned about the price of oil as the planned IPO of Saudi Aramco approaches. In fact, the country changed policy last year after pumping at high levels during the price downturn in order to hold onto market share. Reuters reported in late September that Riyadh threatened to quit OPEC altogether in late 2016 unless the group agreed to limit production, illustrating the lengths to which Saudi officials were reportedly willing to go to increase prices. Saudi Arabia wants oil prices somewhere around $60 per barrel or higher for the IPO, banking sources told Reuters. Full-throated support from Moscow for the production cuts is integral for realizing this goal.

Saudi Arabia and Russia successfully collaborating on manipulating fundamentals and lifting prices, if it continues, will likely have large ramifications for the global oil market in the future, given that both are in a position of strength with high production volumes and large proven reserves.

ADD A COMMENT