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Russia And Saudi Arabia Agree To 1.2Mbd Production Cut

Category: Energy & Environment,Finance

Russian President Vladimir Putin and Saudi Crown Prince Mohammed Bin Salman exchange high-fives at the G20 Leaders' Summit in Buenos Aires, on November 30, 2018.Photo by HO / G20 ARGENTINA / AFP

December 7 marked a much-awaited agreement in Vienna between OPEC and its allies, with high-stakes geopolitics and tumultuous oil prices taking center stage. Brent crude is now hovering around $60 per barrel, a slide of nearly 30% since early October. A combination of rising U.S. shale output and months of sustained production increases from Russia and Saudi Arabia have finally pushed oil prices back down -- much to the dismay of the cartel's price hawks.

Initially, boosting output served the interests of Moscow and Riyadh in the short term – increasing their market share, boosting government revenues, stabilizing the market amidst Iranian declines, and keeping President Donald Trump placated. The two petrostates now have to deal with the consequences of an oversupplied market.

OPEC initially proposed a 1 million barrel per day (bpd) production cut to stimulate prices. But when oil heavy-weight Russia refused to scale back its own output, the group failed to reach a consensus on Thursday, sending prices tumbling further. That changed today as OPEC announced an agreement to slash 1.2 million bpd. According to the Wall Street Journal, OPEC members will be responsible for 0.8 million barrels of the cut (with Saudi shouldering 250,000 bpd), while the non-OPEC group would take the remaining 400,000 barrels. For its part, Russia agreed to cut 230,000 barrels -- a relatively insignificant figure considering the country’s production of 11.4 mbd. Exemptions were given to Iran, Venezuela, Nigeria, and Libya.

But announcing a cut is one thing -- ensuring that all cartel members follow-through with their obligations is another.

That’s not Saudi Arabia’s only problem. In the aftermath of the Jamal Khashoggi murder, Saudi Crown Prince Mohammad Bin Salman (MBS) has faced a maelstrom of criticism from U.S. policymakers. Fearing that he can no longer rely on the United States as an ally, the Prince is desperate to diversify the Kingdom’s geopolitical patrons. Russia and China seem to be willing suitors. In a telltale sign of warming ties, President Putin and MBS shared a memorable high-five at last week’s G20 summit in Buenos Aires.

The countries gathered in Vienna are part of the so-called OPEC+ super-cartel, which includes ten non-OPEC members such as Russia and Kazakhstan. Together, they possess unprecedented influence over the world economy, controlling 55% of global oil supplies and 90% of proven reserves.

Russia and Saudi Arabia are the kingpins of this super-cartel. The second and third largest oil producers globally, they boast respective oil outputs of 11.41 and 10.65 million bpd. World oil demand is now at nearly 100 million bpd, meaning that the two countries together control some 20% of the market. Yet prices still are not exactly where they want them.

From a fiscal perspective, Saudi Arabia needs to reach prices around $88 per barrel to balance its 2018 budget. That being said, the Kingdom does benefit from oil in the $60 per barrel range, as it discourages competition from electric vehicles and also hurts high-cost shale producers. Not to mention cash-starved Iran.

But prices below Saudi’s fiscal breakeven will mean a continued draw-down of their foreign currency reserves. Over the last three years, Saudi accounts have dropped dramatically from around 725 billion USD in January 2015 to 500 billion in August 2018. This is not a promising trend, especially if you adhere to the belief that we are now in the era of ‘lower for longer’ oil prices.

Russia’s fiscal break-even point now stands at $53 per barrel, and President Putin recently stated that a price of $60 would perfectly suit his country’s needs.

Fiscal breakeven prices USDThe Wall Street Journal

The country is in a stronger forex position than its Middle East counterpart. The Russian Federation was able to increase its reserves from less than 300 billion USD in 2015 to 350 billion USD in June of this year. The country’s budget surplus and a weakening ruble (an advantage when oil is sold in dollars!) help explain why Moscow remained calmer than Riyadh throughout these past weeks. It also explains Russia’s growing leverage in Vienna.

But the United States, now the world’s largest crude oil producer and officially a net exporter of petroleum, forms the third critical piece of this puzzle.

President Trump’s zeal to achieve low oil prices is an important issue for OPEC+ but perhaps more important for U.S.-Saudi bilateral relations. The U.S. and Saudi Arabia have a storied history dating back to1945. That year President Roosevelt met the grandfather of MBS, King Abdul Aziz, and agreed to provide military assistance in exchange for secure access to oil supplies. With a few hiccups, and despite the crisis of the 9/11 attack, this relationship has benefitted both tremendously. While Realpolitik might dictate a preservation of this alliance, the Khashoggi case has complicated things significantly. The Kingdom is now seeking an insurance policy for major power patronage.

There is little doubt that Russia and China are eager to see the U.S. – Saudi relationship compromised. Pulling the Saudis out of the U.S. orbit would be a historic geopolitical coup, as both powers seek to undermine America’s top spot in the global pecking order.

Indeed, cooperation between Saudi and America’s top geopolitical competitors is already blossoming. Russia and China are among the five finalists for the construction of two nuclear plants in Saudi Arabia. And much to Washington’s dismay, Riyadh’s wavering support for the THAAD missile shield may mean a victory for Russia’s advanced S-400 air-defense system.

But Russia is faced with conflicting geopolitical interests as well. Moscow still has strong ties with Iran, Saudi Arabia’s bitter rival, and Turkey, a burgeoning Sunni power. What’s more, Russia ’s tough negotiating position when playing ball with OPEC on Thursday shows that it may not be as reliable a partner as the Kingdom hopes.

Just as MBS will have to decide how much it values its long-standing relationship with Washington, Putin will have to weigh the autonomy of its energy sector against gains on the global chessboard vis-a-vis the U.S.

With assistance from James Grant and Balázs Kiss

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Russian President Vladimir Putin and Saudi Crown Prince Mohammed Bin Salman exchange high-fives at the G20 Leaders' Summit in Buenos Aires, on November 30, 2018.Photo by HO / G20 ARGENTINA / AFP

December 7 marked a much-awaited agreement in Vienna between OPEC and its allies, with high-stakes geopolitics and tumultuous oil prices taking center stage. Brent crude is now hovering around $60 per barrel, a slide of nearly 30% since early October. A combination of rising U.S. shale output and months of sustained production increases from Russia and Saudi Arabia have finally pushed oil prices back down -- much to the dismay of the cartel's price hawks.

Initially, boosting output served the interests of Moscow and Riyadh in the short term – increasing their market share, boosting government revenues, stabilizing the market amidst Iranian declines, and keeping President Donald Trump placated. The two petrostates now have to deal with the consequences of an oversupplied market.

OPEC initially proposed a 1 million barrel per day (bpd) production cut to stimulate prices. But when oil heavy-weight Russia refused to scale back its own output, the group failed to reach a consensus on Thursday, sending prices tumbling further. That changed today as OPEC announced an agreement to slash 1.2 million bpd. According to the Wall Street Journal, OPEC members will be responsible for 0.8 million barrels of the cut (with Saudi shouldering 250,000 bpd), while the non-OPEC group would take the remaining 400,000 barrels. For its part, Russia agreed to cut 230,000 barrels -- a relatively insignificant figure considering the country’s production of 11.4 mbd. Exemptions were given to Iran, Venezuela, Nigeria, and Libya.

But announcing a cut is one thing -- ensuring that all cartel members follow-through with their obligations is another.

That’s not Saudi Arabia’s only problem. In the aftermath of the Jamal Khashoggi murder, Saudi Crown Prince Mohammad Bin Salman (MBS) has faced a maelstrom of criticism from U.S. policymakers. Fearing that he can no longer rely on the United States as an ally, the Prince is desperate to diversify the Kingdom’s geopolitical patrons. Russia and China seem to be willing suitors. In a telltale sign of warming ties, President Putin and MBS shared a memorable high-five at last week’s G20 summit in Buenos Aires.

The countries gathered in Vienna are part of the so-called OPEC+ super-cartel, which includes ten non-OPEC members such as Russia and Kazakhstan. Together, they possess unprecedented influence over the world economy, controlling 55% of global oil supplies and 90% of proven reserves.

Russia and Saudi Arabia are the kingpins of this super-cartel. The second and third largest oil producers globally, they boast respective oil outputs of 11.41 and 10.65 million bpd. World oil demand is now at nearly 100 million bpd, meaning that the two countries together control some 20% of the market. Yet prices still are not exactly where they want them.

From a fiscal perspective, Saudi Arabia needs to reach prices around $88 per barrel to balance its 2018 budget. That being said, the Kingdom does benefit from oil in the $60 per barrel range, as it discourages competition from electric vehicles and also hurts high-cost shale producers. Not to mention cash-starved Iran.

But prices below Saudi’s fiscal breakeven will mean a continued draw-down of their foreign currency reserves. Over the last three years, Saudi accounts have dropped dramatically from around 725 billion USD in January 2015 to 500 billion in August 2018. This is not a promising trend, especially if you adhere to the belief that we are now in the era of ‘lower for longer’ oil prices.

Russia’s fiscal break-even point now stands at $53 per barrel, and President Putin recently stated that a price of $60 would perfectly suit his country’s needs.

Fiscal breakeven prices USDThe Wall Street Journal

The country is in a stronger forex position than its Middle East counterpart. The Russian Federation was able to increase its reserves from less than 300 billion USD in 2015 to 350 billion USD in June of this year. The country’s budget surplus and a weakening ruble (an advantage when oil is sold in dollars!) help explain why Moscow remained calmer than Riyadh throughout these past weeks. It also explains Russia’s growing leverage in Vienna.

But the United States, now the world’s largest crude oil producer and officially a net exporter of petroleum, forms the third critical piece of this puzzle.

President Trump’s zeal to achieve low oil prices is an important issue for OPEC+ but perhaps more important for U.S.-Saudi bilateral relations. The U.S. and Saudi Arabia have a storied history dating back to1945. That year President Roosevelt met the grandfather of MBS, King Abdul Aziz, and agreed to provide military assistance in exchange for secure access to oil supplies. With a few hiccups, and despite the crisis of the 9/11 attack, this relationship has benefitted both tremendously. While Realpolitik might dictate a preservation of this alliance, the Khashoggi case has complicated things significantly. The Kingdom is now seeking an insurance policy for major power patronage.

There is little doubt that Russia and China are eager to see the U.S. – Saudi relationship compromised. Pulling the Saudis out of the U.S. orbit would be a historic geopolitical coup, as both powers seek to undermine America’s top spot in the global pecking order.

Indeed, cooperation between Saudi and America’s top geopolitical competitors is already blossoming. Russia and China are among the five finalists for the construction of two nuclear plants in Saudi Arabia. And much to Washington’s dismay, Riyadh’s wavering support for the THAAD missile shield may mean a victory for Russia’s advanced S-400 air-defense system.

But Russia is faced with conflicting geopolitical interests as well. Moscow still has strong ties with Iran, Saudi Arabia’s bitter rival, and Turkey, a burgeoning Sunni power. What’s more, Russia ’s tough negotiating position when playing ball with OPEC on Thursday shows that it may not be as reliable a partner as the Kingdom hopes.

Just as MBS will have to decide how much it values its long-standing relationship with Washington, Putin will have to weigh the autonomy of its energy sector against gains on the global chessboard vis-a-vis the U.S.

With assistance from James Grant and Bal√°zs Kiss


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