Oil Market Stability; Hopes and Fears

Russia and Saudi Arabia recognize the need to contain excess volatility in the market, the statement said. 

The two countries will form a working group to monitor the market and draft recommendations to stabilize oil prices and ensure steady investment in the industry. The group will meet, for the first time, next month.

Novak said a production freeze would be one way to stabilize prices.

Novak described Monday’s announcement as a “historic moment” in relations between OPEC and non-OPEC members.

Given the significance of such an agreement, it would be necessary to examine its various aspects. This article aims at reviewing challenges and obstacles to Russia-Saudi oil agreement.

Optimistically looking, the agreement signed between OPEC kingpin Saudi Arabia and non-OPEC producer Russia would boost hopes for finding a solution to help shore up oil prices which have experienced a sharp decline since mid-2014.

In their statement, the Russian and Saudi ministers have underlined the importance of constructive dialogue and close cooperation with the objective of supporting oil market stability and guaranteeing long-term investment in different sectors for crude oil production enhancement. In case this agreement is implemented several important events are likely to happen.

First of all, in the light of such an agreement, the oil price will be stabilized at $50 a barrel, which is currently touted by most oil producers.

Second, oil price at $50 would call into question the profitability of shale oil production in the United States. That would drive the main rival to conventional oil out of the market for some time.

Third, implementation of the Russian-Saudi accord would pave the ground for future cooperation between Moscow and Riyadh, as they are currently at loggerheads over many regional and international issues.

Challenges to Agreement

Despite projections for a positive outcome, the Saudi-Russian agreement or even a deal between Russia and the Organization of the Petroleum Exporting Countries (OPEC) are likely not to bring about oil price hike. The reasons are as follows:

1. The agreement reached between Russia and Saudi Arabia is so ambiguous. This ambiguity could be seen in somewhat contradictory remarks by oil officials of the two countries. The Saudi energy minister has said that “Saudi Arabia and Russia will take advantage of their prominent status in the oil production market”. “These two countries share a motivation, i.e. bringing stability to international oil market. At present, freezing the oil output level is not on the agenda and does not seem necessary,” the Saudi minister said. But Russia’s Novak said: “We have reached agreement to cooperate for oil market stability and forecasting future developments”. These contradictory remarks by Russia and Saudi oil officials show that the Russians are supportive of stability in the oil market, while the Saudis do not envisage freezing oil output level. These official stances by Riyadh and Moscow show that the two countries do not pursue any specific and unique strategy for controlling global markets and shoring up crude oil prices.

2. What led Russia and Saudi Arabia to reach this agreement was economic challenges. This agreement is not viewed as rapprochement in strategic relations between the two countries. Russia and Saudi Arabia are at odds over a variety of issues including political and regional affairs, terrorism, security and extremism. As a result, their cooperation in the economic sector will not last long because any political tensions in their relations would annul or undermine economic agreements. 

3. The idea of oil output freeze is just a show and will not help the market at all because OPEC is pumping at full capacity and any freeze in production would not significantly affect world markets. In a bid to make up for sharp declines in their oil revenues, the producers have had to increase their exports. Freezing the oil production at the January 2016 level would not cut oil supply by these countries. The first step for the formation of a realistic idea that would help increase oil prices would be to cut the output level, but it is unlikely to be agreed upon by oil producers. None of these countries, whether OPEC or non-OPEC, would be ready to reduce its production and subsequently its petrodollar gains. Saudi Arabia has already maximized its output to more than 10.6 mb/d in a bid to ease the strain on its oil-dependent economy. Russia has been also raising its oil production over the past one year. It has brought its output from around 10.2 mb/d in January 2015 to more than 10.4 mb/d in April this year. Other countries that have been supporting the idea of oil output freeze are also in similar conditions. For instance, Kuwait has increased its oil production from 2.85 mb/d to 3 mb/d over the past year. In fact, the proponents and supporters of the idea of oil production freeze have had to boost their output over the past one year and it seems that there are no proper grounds for such an idea to materialize. If Russia and Saudi Arabia decide to follow up on the idea of oil production freeze, they have first to quit increasing their output, but such a plan would be impossible for Russia and Saudi Arabia, whose economies have been harmed seriously by oil price fall. Russia’s top oil producer Rosneft has seen its net profits fall sharply by 80% during the first quarter of 2016 from a year ago. Rosneft’s first-quarter profit was reported at $200 million, much lower than the $800 million recorded in the first quarter of 2015. Meanwhile, Russia’s second largest oil producer Lukoil released its financial report for the first quarter of 2016, showing a 59% in its net profits year-on-year. Furthermore, economic challenges in Saudi Arabia in the aftermath of oil price decline have gone beyond budget deficit and monetary shortfall. The Saudi government and firms are unable to pay thousands of foreign workers. Abandoned in desert camps, foreign workers have said that they would not accept the Saudi government’s offer to repatriate them on free flights. They insist on receiving their back wages, now due more than eight months. The main reason behind unemployment and non-payment of salaries is the decline in oil prices and the economic stagnation of the Saudi kingdom.

4. The idea of oil production freeze will not be welcomed by all OPEC and non-OPEC oil producers. Most countries whose national revenue heavily depends on oil are not ready to maintain their output at the current level and they have plans to enhance production and exports in order to relieve economic pressures. Therefore, it would be widely unlikely that other oil producers join Russia and Saudi Arabia in their planned oil production freeze.

5. In rivalry with Iran, Arab countries, particularly Saudi Arabia, will not agree to keep their production unchanged. While Iran is making every effort to claw back market share it lost due to years of international sanctions, many Arab countries are calling on Iran to freeze its production.

Generally speaking, as Saudi Arabia’s obstructionism killed any chance of reaching an agreement on oil output freeze at the Doha meeting, the Arabs’ stubbornness vis-à-vis Iran would block any comprehensive deal in the future in this sector.

Different Approach on Iran

Russia and Saudi Arabia are largely divided regarding their views of Iran’s oil production. While Saudi Arabia wants Iran to freeze its oil production, Russia has openly said that Iran must be allowed to bring back its output to the pre-sanctions level. In fact, Russia is supporting Iran’s oil supply return to the pre-sanctions level, while Saudi Arabia remains opposed. That could pose challenges to future cooperation between Moscow and Riyadh about freezing oil production.

In conclusion, joint action by Saudi Arabia and Russia for bringing back stability to crude oil market and strengthening prices could not be viewed as a permanent agreement. As Russia and OPEC failed to reach agreement in early 2016 on oil production freeze, such a consensus is still unlikely to be reached in the future.

By Shuaib Bahman

Courtesy of Iran Petroleum Monthly