Russia wins on oil deal as Saudis keep careful eye on Trump

Micha’el Tanchum

Last weekend OPEC and non-OPEC producers reached a historic deal, the first since 2001, to curtail oil output jointly and ease a global glut after more than two years of low prices.  While the deal was a diplomatic and economic coup for Russia, Saudi Arabia will still determine whether oil prices will continue to rise during 2017. Riyadh’s maintenance of higher oil prices will depend on its perception of actions taken in Moscow and Tehran as well as Washington.

Russia, Oman, Mexico, Azerbaijan, and seven other non-OPEC producers agreed to reduce output by 558,000 bpd starting from Jan. 1, 2017 for six months, extendable for another six months, to take into account prevailing market conditions and prospects. Earlier, OPEC agreed to slash output by 1.2 million barrels per day from Jan. 1, with top exporter Saudi Arabia cutting as much as 486,000 bpd.

Despite the significant cuts by Riyadh and some other OPEC members, the production cuts in several of the non-OPEC countries will be more politically symbolic than anything else. For example, Oman’s pledge of a production cut of 40,000 bpd is equivalent to one supertanker load per month. Mexico and Azerbaijan’s reduction pledges do not seem to be real production cuts, but are simply counting expected natural declines in production as output cuts.  

Russia’s reduction pledge likewise does not constitute a cut in current production. Moscow planned to increase production in 2017 by 200,000 bpd to reach 11.48 million bpd, according the International Energy Agency.

 Moscow joined the OPEC reduction pledge by agreeing to freeze planned production increases. Through clever diplomacy, Russia is now receiving more revenue without cutting actual production.

The rate of storage among the major producers is crucial to understanding whether and to what extent compliance is actually taking place. Saudi Arabia will be watching Russia and Iran quite carefully. Iran may choose to put a portion of its output into storage without really cutting production, in order to appear to comply with the OPEC pledge. Russia may opt for this approach as well, especially as oil prices rise.
 
Storage may also have a self-reinforcing effect. If storage provides a false impression that there is strict production cut compliance, then buyers will also increase the level of storage. If widespread, such misjudgment could have disastrous consequences for the oil market and the global economy.

The anticipated reset in U.S.-Russia relations under Donald Trump, especially if sanctions enforcement is eased, may have unintended consequences on the OPEC reduction pledge as Saudi Arabia may re-assess its position. Even more consequential for Riyadh is the possibility of a rapid increase of drilling in the shale basins in the U.S. southwest under the new Trump administration. Trump’s nomination of Oklahoma Attorney General Scott Pruitt, an ardent proponent of fracking, to head the U.S. Environmental Protection Agency, and the nomination of former Texas Governor Rick Perry to head the U.S. Department of Energy, suggest that U.S. shale production may expand.

If Saudi Arabia perceives the market not to be balancing it will intervene. If oil climbs well above $50, several producers will begin to less strictly comply with the production/export reductions, Riyadh will threaten to reduce the price through expanded production to reinforce compliance among backsliding nations. This would cause wobbles in the market, but if managed well, the overall trend would be upward.

However, a ramp-up of U.S. shale production would likely cause a Saudi rethink and possibly Riyadh’s rapid intervention to reduce oil prices in order to stymy the development of additional U.S. shale production capacity. While Riyadh will be turning a watchful eye toward Moscow and Tehran, its main scrutiny will be focused on the new energy policies coming out of Washington.

* Dr. Micha’el Tanchum is a fellow at the Energy Policies Research Center at Bilkent University in Ankara, and the author of the ‘A Post Sanctions Iran and the Eurasian Energy Architecture’ published by the Atlantic Council.