Oil: Edging Closer to a March Output Deal

Published on February 11, 2016
SGH Insight
“We take the news of a possible visit in March to Moscow by Saudi Arabia’s King Salman bin Abdul Aziz Al Saud very seriously, as potentially marking the culmination of an extended, high-stakes diplomatic maneuvering between the Kingdom and Russia to reach terms on both an OPEC, non-OPEC oil output cut as well as the resumption of the Syria peace negotiations in Geneva. … On the oil front, there is still nothing more than a basic framework to an agreement for now, and the negotiating process is fraught with potential setbacks, for instance when it comes to the actual terms of market share, quotas, or production standstill agreements and the like; but we do believe as we first reported in January, there has been steady, even substantial movement towards an eventual agreement between the OPEC and non-OPEC oil-producing countries for a coordinated cut in crude oil output, probably sometime in March …
Market Validation
(FT 2/12/2016) -- Oil prices rose by more than $2 a barrel on Friday in volatile trading.

Brent, the global benchmark, increased $2.49 a barrel to $32.56 while West Texas Intermediate, the US marker, jumped $2.92 a barrel to $29.15 in afternoon trading.

Market chatter and comments from the UAE oil minister pointed toward potential collaboration on production cuts between Opec and non-Opec producers, which helped to buoy markets.

We take the news of a possible visit in March to Moscow by Saudi Arabia’s King Salman bin Abdul Aziz Al Saud very seriously, as potentially marking the culmination of an extended, high-stakes diplomatic maneuvering between the Kingdom and Russia to reach terms on both an OPEC, non-OPEC oil output cut as well as the resumption of the Syria peace negotiations in Geneva.

 

*** On the oil front, there is still nothing more than a basic framework to an agreement for now, and the negotiating process is fraught with potential setbacks, for instance when it comes to the actual terms of market share, quotas, or production standstill agreements and the like; but we do believe as we first reported in January (see SGH 1/21/16, “Saudi Arabia: Lending a Hand”), there has been steady, even substantial movement towards an eventual agreement between the OPEC and non-OPEC oil producing countries for a coordinated cut in crude oil output, probably sometime in March. ***

 

*** An essential prerequisite to the Saudi visit to Moscow and for an oil deal is whether there is progress towards a cease-fire is agreed to in Munich. We believe it is likely, within days at most if not hours, and the March 1 start date to the cease-fire initially proposed by the Russians will be brought forward, albeit with likely concessions by the Saudis and the Americans on the terms to a resumption of the Syria peace negotiations in Geneva and the badly needed resumption of humanitarian aid inside Syria. But it should clear the way for the understanding between Moscow and Riyadh, paving the path to an OPEC, non-OPEC agreement on an oil output cut. ***

 

A few key points.

 

First, we say the “possible” visit by the King to Moscow because the visit, initially announced in the Russian media, has yet to be officially announced in Riyadh. It is our understanding Saudi officials will wait to confirm the visit, perhaps using it as negotiating leverage to help bring forward a Russian-proposed March 1 cease-fire to the fighting in Syria that is being discussed in Munich by the International Syria Support Group, the 20 or so countries with interests in the Syrian conflict, led by the US and Russia, and which includes the Saudis.

 

We do think there will be both a cease-fire and a confirmation of the King Salman visit, which was in fact first broached last year during the visit to Moscow by the King’s son, Deputy Crown Prince Mohammed bin Salman. Everything we are seeing now is still part of the negotiating process, be it the Venezuelan tour of oil producers, the assertion of an OPEC deal by the Emirates oil minister today, or the opening Russian offer of a March 1 cease-fire in Syria.

 

And while there are certainly multiple players in the process, success or failure on both the oil and Syrian fronts will revolve entirely around the negotiations underway between the Saudis and the Russians. Crucially, the leaders in both capitals see oil policy and Syria policy as implicitly, if not explicitly, linked.

 

The Russians have positioned themselves to hold the dominant negotiating cards in Syria by providing massive air and logistical support, including advanced armor, to the Syrian army offensive to encircle and defeat the Saudi and Turkish-backed rebel forces in Aleppo and to the south, in the approaches to Daraa. The Syrian ground offensive is also supported by fighters from the Lebanese Hezbollah and the Iranian Revolutionary Guard, and somewhat awkwardly for US-Turkish relations, Kurdish fighters controlling the ground to the west of Aleppo.

 

The Saudis believe their main negotiating leverage in Syria lies with their influence over the oil market, and Saudi oil and regional foreign policy were within the last year consolidated under the Deputy Crown Prince.

 

On the one hand, the Saudis are willing, and able, to withstand the budgetary or currency pressures in current oil prices or even another decline in prices. They have already made a first round of budget cuts, and they have the financial resources to sustain budget deficits for several years, and they are well positioned to defend the riyal peg to the dollar against any speculative waves (SGH 11/23/15, “Saudi Arabia: A Devalued Riyal Peg Highly Unlikely”).

 

But as we noted in the earlier report on the Kingdom (SGH 1/29/16, “Saudi Arabia: Building Towards Firmer Oil Prices”), there are domestic political pressures building that are pushing the Saudi leadership towards the effort to stabilize and lift oil prices moderately higher in the near term, and to work towards an end to the regional hostilities in both Syria and Yemen.

 

That pressure, from what we understand, lies not in the budget numbers, but in the the weakness in the domestic stock and real estate markets that are an important political barometer of the standing of the Al Saud ruling family, and Deputy Crown Prince Mohammed in particular.

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