Russia Wants To Play Let's Make A Deal: Will The Saudis Comply?

|
Includes: BNO, DBO, DNO, DTO, DWTI, OIL, OLEM, OLO, SCO, SZO, UCO, USL, USO, UWTI
by: Kal Telage

Summary

A proposed deal to cut crude production by Russia triggered a spike in oil prices above recent lows.

Dependency on oil revenues is straining the budgets of both Russia and Saudi Arabia to support their economies and maintain order among their citizenry.

Iran's ascendancy is a threat to past Saudi regional dominance. With lifted sanctions and a major cash infusion, Iran is preparing to increase the global glut with more oil.

Iran's goal of Middle East hegemony decreases prospects for a Saudi-Russian deal and heightens the threat of future Iranian-Saudi confrontations. The Sunni-Shia divide broadens.

Some pros and cons for future oil prices are considered.

Russia proposes Oil Cuts

Russia's Energy Ministry reported that a deal to cut oil production was proposed to OPEC sparking higher crude prices. The deal suggested a 5% cut for participants with Russia reducing their output by 500,000 bpd.

Crude Surges

Talk of a deal sparked an 8% rally in oil prices with Brent crude closing at 34.50 on January 28.

Graph Courtesy of the Author

Oil Glut Spells Big Trouble

Major oil producing countries are besieged by crude prices falling to 11year lows as global demand weakens. The ramifications are only starting to be felt.

Russia and Saudi Arabia

Frigid Russia and broiling Saudi Arabia are a tale of two countries sharing insufficient economic diversity to sustain economic growth. Both are inextricably tied to oil production as the major impetus for creating the financial means required to run their countries.

As the world's third and second largest respective oil producers, they are strained to the breaking point by dramatically cheaper oil prices that maintain high production rates. The effects of cheap oil place their economic and political stabilities at risk backing them into a corner, a dangerous condition. Indeed, it begs the question, does a Russia-Saudi oil slowdown loom?

Russia

Russia's dependency on oil revenue is estimated at 67 to 70% of GDP pressing Russia to push production to a record high of 534 million tonnes of crude in 2015.

Russia faces a revenue crisis, restricted imports, a decline in foreign reserves, and growing inflation. This implosion is causing widespread labor unrest and instances where private-labor workers remain unpaid. There is always concern that a citizenry can revolt, even in a police state, as they did in 1962 during a labor strike. It ended when the red army killed scores of them.

Russia's economic woes were exacerbated by ending their previous dual currency soft peg. This has allowed the ruble to become a free floating currency. As oil declined, so did the ruble's value to an undefended all time low.

A stronger U.S. dollar as well as other stronger foreign exchange currencies result in Russia's inability to pay for needed imports, less foreign reserves and increasing inflation at home.

Saudi Arabia

The Saudis have been adamant about maximizing oil production to protect their Asian markets. They adopted a "last man standing posture" which has succeeded in inflicting considerable damage on many U.S. shale producers. There are internal ramifications for the Saudi actions now that oil prices are much lower.

Without question, Saudi Arabia, like Russia is a brutally repressive police state ready to crush political dissent. While the Arab Spring toppled four Middle East countries, the Saudi family has managed to maintain order through lavish domestic subsidies. But this has come at a cost that must be paid with diminishing oil revenues.

Additionally, the Sunni Shia divide for hegemonic dominance in the Middle East pits the Saudis against Iran.

Map Courtesy of the Author

This has produced additional costs for a military build up that exceeds Iran's military expenses by 7 to 1. Like Russia, Saudi Arabia is beginning to feel the consequences of operating with diminished oil revenues. The question remains, are both their overall concerns significant enough to reduce oil production?

Russian-Saudi Cuts Remain Elusive

In the context of this perfect storm oil glut, and with diminishing global demand for oil, I don't think cuts will occur in the near term. At this time, Saudi oversupply is only 500,000 bpd. However, the U.S., Saudi Arabia and Russia are all pumping in excess of 10 million bpd. In my opinion, effective cuts might demand greater reductions than Russia or the Saudis can afford.

This is significant in the face of Congress lifting the U.S. oil export ban which has been in effect for 40 years. This will reduce the geopolitical influence of other dominant oil producing nations.

Iran is determined to reestablish past oil output levels subsequent to the removal of sanctions that restored billions of dollars to their coffers. Prime Minister Rouhani has traveled to Rome and Paris for talks with Italian and French oil companies to help ramp up Iran's oil production. Clearly, there is uncertainty concerning how much Iran's increased production will add to the world's growing glut. In such a climate, it may prove difficult, if not impossible, for major producers like Russia and Saudi Arabia to shut off the spigots.

OPEC Delegates Reject Russian Proposal

Bloomberg has reported that OPEC delegates have no plan for talks. It took OPEC little time to say no to a meeting with Russia. Although this may be the first round in hard negotiations, there will not be any discussions until a meeting is convened.

Considerations

Without significant cuts in global production, the likelihood for higher oil prices is questionable. In the near term I would look for oil prices to test their recent lows. If oil breaks below the latest support levels, this could signal further oil price declines. If prices hold above the lows, expect price volatility within a range as the market reacts to changing conditions.

Geopolitical Implications

The geopolitics of Saudi Arabia and Iran pose a threat for increased global instability and bear close scrutiny by investors. Oil may be a valuable and indispensable commodity, but for nations that are major producers, it is also a geopolitical weapon of war. The chaos of the Middle East is a powder keg waiting to ignite. if armed violence disrupts oil output, there is no telling where the price of oil may go.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.