Saudi Arabia: The OPEC Debacle

Published on March 8, 2020

In a dramatic and unprecedented turn of oil politics gone awry that has stunned already fragile global markets, these last 72 hours saw Russian officials walking out of the OPEC+ meeting in Vienna on Friday, fuming over Saudi efforts to strong-arm the other OPEC+ member states into a larger and longer than expected additional 1.5 million barrels per day in output cuts, and now Saudi Arabia has responded to the Russian recalcitrance by announcing it would slash prices, signaling an all-out war for market share between the two oil producing giants.

Crude oil prices are collapsing by the hour with Asia’s opening, and the shockwaves are being felt in Riyadh as well across global markets.

** The oil price collapse in the wake of the OPEC+ meeting debacle is for real, and looking to be sustained, with Saudi officials saying West Texas Intermediate crude prices likely to freefall below $30 a barrel and down to probably at least $25 a barrel before some sort of demand floor is reached. Other OPEC officials are scrambling to bring the Saudis and Russians back to the table at a mid-March meeting of the OPEC+ joint monitoring committee in a desperate attempt to revert to an agreement on output cuts and new quotas.

** There is some thought, or straggling hope still, the freefall in prices will push both oil superpowers into a face saving compromise to limit the collapse and potentially reverse some of the price collapse, by agreeing to maintain the existing 1.2 million bpd in output cuts and to agree on the original 600,000 to 1 million bpd in new cuts, almost all of which would be absorbed by Saudi Arabia, Kuwait, and the United Arab Emirates.

** Even if there is such agreement, those amounts, however, are likely to now prove to be too little and too late, the ripple effects of the oil price shock are already spreading across the global economy; furthermore, an agreement without Russian cuts would at this point prove highly embarrassing for Riyadh, and indeed, complicating any hope of stepping back from the oil price collapse is the now enormous public face at stake for both sides.

** Saudi Arabia has already begun ramping up its output from the 500,000 bpd Neutral Zone shared with Kuwait, and the pricing offered yesterday by Saudi Aramco to its customers underscores its willingness, and capacity, to increase output by as much as 2 million bpd within months.

** Russia, on the other hand, can increase output by only perhaps another 300,000 bpd. But its economy is much more insulated from falling oil prices, in part, because a weaker ruble in effect offsets the loss of dollar revenues, and Moscow seems reluctant to agree to any output cut, especially with US shale producers outside the agreement and free to take market share, even with oil prices now free-falling below US breakeven levels.

** We understand that for any new agreement, the Saudis will now demand the Russians make real rather than token cuts in output and at the beginning rather than the end of the agreement period, and that seems unlikely to be forthcoming.

** If there is to be a new broader, wider agreement, it will have to build off the JMMC meeting in March, but under current circumstances it is far from clear what any agreement exactly would entail, or if the technical meeting will be even held then at all.

An Enormous Saudi Miscalculation

It is clear now, in the afterglow of the meeting debacle, that the Saudi energy minister, Prince Abdul Aziz al Salman, acting on behalf of his half-brother, Crown Prince Mohammed bin Salman, spectacularly miscalculated in how Russia’s Energy Minister Alexander Novak and President Vladimir Putin would react to what was essentially a take or leave demand on Thursday to extend existing 1.2 million bpd in output cuts and add another 1.5 million bpd in cuts to year-end, with Russia and the other non-OPEC members contributing a half million bpd in the cuts.

The Saudi misstep with Russia is in fact reminiscent of the bungled OPEC talks in February 2016 in Doha when MbS intervened to push then oil minister Ali al-Naimi into an impossible negotiating position with Iran that broke apart the initial effort to move back to a price rather than market share strategy. Ironically, it was the intervention of the Russians at a subsequent OPEC meeting in Algiers that turned prices around then and led to the Vienna framework agreement for the first of the output quotas that stabilized oil prices for the next two years.

We understand that going into this meeting, Russian officials were firmly unwilling to cut their output from the start, and at most were willing to offer they would refrain from increasing their crude output. President Putin had met with the heads of the Russian oil producers and key ministers last Sunday in Moscow, all whom expressed their reluctance for additional output cuts, and there was already a Russian resentment the Saudis were not fully appreciative of their strategic interests.

The Russian oil producers are betting “temporarily” lower prices due to the coronavirus impact will in fact limit any sustained fall in demand, and they were making exactly that point for weeks with the Saudis, including in a call put to President Putin by King Salman. There is at its heart a fundamental split in how the two giant oil producers see the threat to the oil market from the coronavirus impact on demand, and how to weather that storm.

Much has also been made of the Russian ambitions to undermine the US oil shale producers who the Russians have complained are steadily taking away market share from the OPEC+ producers trimming output to protect prices. It is fair to say the Russians (and the Saudis, but less overtly) will not be unhappy with the damage to the US shale producers, but it was not the only driver to Moscow’s policy stance going into the meeting.

Saudis Already Weighing Market Share Option

The Saudis themselves were for several months feeling equally frustrated with what they saw as Russian recalcitrance, and in Riyadh, there had already been discussions over the merits in a return to a market share strategy, though more in terms of next year rather than this week in order to first shore up prices before a long planned international leg to a Saudi Aramco IPO later this year.

Saudi officials were positively stunned by the Russian response on Friday, and were assuming right to the very end that the Russians would relent and at least cede to some token commitment to output cuts in order to give an “OPEC cover” to the Saudis and the Gulf oil producers proceeding with the lion’s share of actual output cuts.

Instead, the existing 2.1 million-barrel-a day supply reduction will expire by the end of March, with producers free to pump and sell as much crude as they can manage. And Saudi Arabia already cut its official selling prices for Arab Light by $6 to Asia, and $7 to the US for April cargoes.

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