Global Oil: Russia And Saudi Arabia - On A Shaky Common Ground

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President Putin this morning reiterated Russia’s position in the production control negotiations.

While Russia’s “bid” falls far short of Saudi Arabia’s “ask,” Russia may win this negotiating round.

However, to achieve a durable oil price response, OPEC and Russia need to achieve market re-balancing in substance, not just before the media.

Saudi Arabia has significant negotiating power, as its sponsorship for the production pact is vital for Russia's and other producers' export revenues.

Recent comments by officials of major oil exporters have conveyed near-uniform optimism that production control measures will be agreed to at the OPEC meeting on November 30 in Vienna. However, statements also reveal significant bid-ask gaps that still appear to exist between various OPEC and non-OPEC members and need to be resolved, one way or the other, in the next ten days.

One of the most important nuances worth paying attention to is the term that oil and government officials use when they refer to the proposed production control initiative: "production cut" versus "production freeze." Saudi Arabia and several other OPEC members have been advocating a production cut agreement, whereas Iran and Russia have continuously insisted on a production freeze (in any event, in application to themselves). The divide is obviously significant and may lead to a spike in tensions as the OPEC meeting next week approaches.

Russia's participation in the agreement and its contribution to production control is a significant topic on the agenda. For the time being, Russia's position on the issue appears clear. Over the last several weeks, Russia repeatedly signaled that it is not prepared to agree to any production cuts but would offer a production cap at a level equal to its recent production. Of note, according to Russia's official oil statistics, the nation's production in October reached new highs.

This position was reiterated in a newswire circulated this morning by TASS, Russian government's central news agency:

LIMA, November 21. /TASS/. Russian President Vladimir Putin believes the chances for reaching an agreement on a freeze the output of crude oil by OPEC exist.

"We're prepared to freeze the output at the current level," he said as he addressed a news conference upon completion of the APEC summit in Peru.

"We don't see any damage for our energy sector," Putin went on. "The energy minister maintains permanent contact with leading oil companies and they're prepared for efforts of this kind."

"I can't say with a hundred percent assuredness an agreement of this kind will be reached but there is a great probability it will be," he said.

"The contradictions within OPEC - if they haven't been eliminated yet can be ironed out because no acute problems exist there now," Putin said.

"And we on our part are doing everything what our OPEC partners expect of us," he said. "At any rate, there is no problem for us to freeze production."

OPEC countries reached a decision at a conference in Algeria on September 29 to freeze the output of crude in order to stabilize the prices but they failed to draw up a roadmap for how to cut down the output volumes.

A conference on adopting a decision to stabilize oil production is to take place on November 30. Non-OPEC producers may join it if a relevant agreement is attained.

The position expressed by Russia's ultimate decision maker (certainly as it relates to these negotiations) is unambiguous.

Will Saudi Arabia be willing this time to live with Russia's less-than-generous contribution to price stabilization?

As a reminder, Russia was an initiator and vocal advocate of a production freeze earlier this year, using an intense informational campaign in international media and heavy diplomatic effort to push the freeze initiative onto the discussion agenda within OPEC. In the meantime, Saudi Arabia's position had been made clear: the kingdom had stated on multiple occasions that it was prepared to support a production control agreement as long as other exporters were prepared to share the burden.

Russia's production freeze campaign last spring ended in a fiasco, as the promise that Iran would contribute a fair share to the effort did not materialize. It is also unclear whether Russia itself formulated a compelling proposal with regard to its own production ceiling and monitoring mechanisms.

This time, the chances that Saudi Arabia will accept Russia's pledge to freeze production (or reduce production by a nominal amount) are significantly higher, in my view. The key difference from the situation in the beginning of this year is that Saudi Arabia is now the primary sponsor of the production control initiative and is likely interested in delivering a result at the meeting in Vienna, even if a portion of that result represents mostly a media relations value. In order to preserve progress achieved in negotiations with Iran and other OPEC members, a compromise with Russia, even if painful, is certainly conceivable.

The acceptance could also reflect elements of real politik: the agreement itself is only worth something if the compliance can be verified and enforced. Verifying Russia's compliance, particularly at the production level, is highly problematic, in my opinion. With government-controlled oil industry and statistics, volatile domestic demand and multiple points of export, a case can be made that Russia would have little difficulty rejecting any potential accusations that it has exceeded its quota.

In this context, Saudi Arabia's choice is binary.

The first option is to unilaterally (or, possibly, with support of the closest GCC allies) "underwrite" the price stabilization effort and try to get the best deal possible from other exporters. Under such scenario, any contribution from other producers - in the form of a cut or a freeze - is better than nothing.

The second option is to walk away from the deal and default to a market forces-based strategy.

The choice appears to have already been made. So the agreement in Vienna is to a great degree Russia's, Iran's and Iraq's to lose. This tentative success is not ironclad, however. The agreement can be derailed if the critical mass of poor negotiation outcomes renders the agreement blatantly hollow. In that case, Saudi Arabia would have to think very carefully about pros and cons of signing an unfavorable commitment. The kingdom's hard-earned credibility is certainly at stake.

While the risk of the agreement being derailed still exists, it should be noted that all oil exporters obviously understand that they have a lot to gain from a production cut success. In that regard, Saudi Arabia is in the driving seat and should be able to dictate the terms, at least to some degree. It appears logical that the majority of exporters should end up cooperating with Saudi Arabia at this stage and deal with the inconveniences later.

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