After a positive week oil prices fell for the second consecutive day yesterday. The jury is very much out whether a top was found last Friday and/or Monday, or this is just a temporary, albeit sharp, downside correction. Whatever the case may be the current weakness can be attributed to three developments (or the lack of it). Firstly, and perhaps most importantly the blurred picture surrounding the outcome of Phase One of the trade negotiations makes investors wary. President Trump said yesterday that he would go on raising tariffs on Chinese imports if no deal is reached. These tariffs are set to be implemented on December 15, a date to be pencilled in any trading diary.

Secondly, Russia is reportedly reluctant to endorse deeper cuts in oil production when the OPEC+ group meets in Vienna in two weeks’ time. This headline had bulls running for the exit, but the practical impact should not be overly concerning. Finally, the usual weekly report on US oil inventories is forecast to register yet another increase in crude oil stocks. Analysts expect to see this build to be 1.5 million bbls and the API last night put the figure at 6 million bbls – hence the renewed weakness this morning. Considering the upcoming OPEC+ meeting on December 5 & 6 and the possible implementation of Chinese import tariffs on December 15 certainty and clarity will probably be in short supply for the next three weeks.

The view from Moscow

We recently argued that OPEC is left with little option but to reduce output further if they want to prevent global oil inventories from growing next year. We concluded that the best way to do it is to continue with the existing quota discipline and force Iraq and Nigeria to bring their own output in line with the required levels. Whilst this seems to be the most reasonable course of action at the beginning of December it will be intriguing to learn whether the second biggest oil producer in the world, Russia, would support such an idea. After all, what has been achieved in 2019 is the teamwork of OPEC and ten non-OPEC producers with the latter group led by Russia.

The most important goal of the next OPEC+ meeting must be that non-OPEC members agree on keeping their end of the bargain throughout 2020 otherwise the historic agreement that has been in place since 2017 will fall apart and so will oil prices. So, what’s in Russia’s interest – keep producing at the reduced rate or go its own way? Yesterday Russian sources told Reuters that it is unlikely to advocate deeper cuts but could support extending the current deal. Although oil prices fell on the news this is exactly what OPEC would need to keep the chances of reducing oil inventories next year alive.

The facts are as follows – the OPEC+ agreement that was amended in December 2018 requires participating countries to reduce their output by 1.2 mbpd from the October 2018 level. The base line is 10.633 mbpd for Saudi Arabia and 11.421 mbpd for Russia. The required cuts are 322,000 bpd or 3.03% for the Kingdom and 230,000 bpd or 2.01% for Russia. It is fair to say that Saudi Arabia has shown a much bigger commitment to the deal than Russia. Looking at the October numbers Saudi Arabia produced 9.89 mbpd, a compliance of 230% (secondary sources). Russia’s output was 11.229 mbpd (Energy Intelligence estimate), above the quota reaching an adherence of 83%. The latest available JODI data shows that Russian crude oil exports rose from 5.268 mbpd in October 2018 to 5.458 mbpd in July 2019 (+3.6%). During this period the Kingdom reduced its crude oil exports by slightly over 10% and by 13% between October 2018 and September 2019. The point is that Russia has more to lose than Saudi Arabia in case the co-operation comes to an end as they would not be able to increase their output as much as the Saudis. It is also worth noting that the chief executive of the Russian Direct Investment Fund (RDIF) estimated back in June that the pact between OPEC and non-OPEC producers had lifted his country’s budget revenues by $110 billion. According to his energy minister Russia will receive and extra $31 billion in revenue this year from the OPEC+ deal. Financially Russia is an obvious beneficial of the output agreement.

The political relations between the two oil producing nations also imply that this marriage of convenience is set to continue. In October Vladimir Putin paid his first visit to Saudi Arabia for 12 years. There was everything one can wish for: red carpet rolled out, 21-gun salute, audience with the king and meeting with the crown prince. On the side-lines, the delegation that accompanied the Russian president left with bilateral trade deals worth $2 billion and twenty agreements have been signed. Discussions touched on the possible purchase of Russian air defence missile system. During the time of the visit the RDIF announced a deal with Aramco to acquire 30% of a Russian oil equipment supplier and potential co-operation between Gazprom and Saudi companies on natural gas.

Clearly, the Saudi foreign policy has changed direction in the past few years. One might argue that it all started with the Obama-brokered Iranian nuclear deal, which alienated the Kingdom. The murder of the Saudi journalist Jamal Kashoggi led to an international outcry and an almost worldwide condemnation. Only the Russian
president stayed silent and even supportive. Finally, the relentless growth in US oil production and the growing oil independence of the world’s biggest economy naturally make the two once-allies less of friends. Russia is ready to fill the vacuum.

So, it is a no-brainer for Russia to continue the path of the last two years of managing global oil supply, is it not? Seemingly it is but domestic issues might not favour such an approach. Whilst Saudi Arabia needs an oil price of over $80/bbl Russia is happy with $60/bbl and to balance its budget it could live with a price as low as $40-$42/bbl. Secondly, Russian producers have been lobbying for lifting oil production. The commitment to reduce output acts as a break on exploration. Finally, the president’s approval rating, albeit low, does not show any close relationship with economic growth and therefore high oil prices. Putin does not have to worry about losing (further) popularity in case oil prices drop $10-$15/bbl. After putting the pros on one side of the scale and the cons on the other one would be reasonably confident that this scale will be tipped in favour of continuous co-operation between the producing heavyweights. And this partnership will not require Russia to commit to deeper cuts, only to stick with the current one.