How the Russian-Saudi oil war went “not according to plan”

US, WASHINGTON (ORDO NEWS) — It seems that the last of many seemingly unshakable systems destroyed by the COVID-19 pandemic is the global oil markets and how the world’s largest energy exporters measure their own power and profit. On Sunday, after a month-long oil war, which halved prices, the two main participants in the conflict – Russia and Saudi Arabia – are believed to have reached a ceasefire, in which oil-producing countries will cut production by almost 10 million barrels per day.

President Trump made himself a peacemaker and vaguely spoke out that the United States will also reduce its oil production.

This new multilateral agreement for oil producers, concluded with the unprecedented participation of the United States, appears to be a new form of energy diplomacy with possible serious consequences at a time when the world economy is extremely unstable and is likely to face a recession. But the fact is that this agreement may turn out to be only a short-term measure – and it is possible that Russia, a country that, to a greater extent than all the others, provoked this confrontation, will ultimately look like a player who has gone too far, fairly overestimating their capabilities.

The world looked completely different just a month and a half ago, when Moscow and Riyadh decided that they had an advantage over each other, and political leaders in both capitals felt that they, and not their rivals, were better prepared to withstand financial the hardships of a price war. Both countries reached a compromise on a future reduction in production as part of the OPEC + group, created in 2016, when Russia and a number of other oil producers (but not the USA) joined the existing cartel members. Their calculation was based on a simple market economy: manufacturers agreed to limit supply in order to prevent prices from falling.

At first, this agreement partially yielded results – oil prices rose from a minimum of $ 27 per barrel in 2016 to more than $ 60 by the end of 2019. But it was far from ideal. For climatic and geological reasons, Russian oil wells are more difficult to adapt to different conditions than Saudi ones: they cannot simply be closed today and reopened tomorrow. In Russia, a decrease in production volumes can lead to damage to wells and the loss of some fields for many years, if not forever.

This meant that Russian oil companies continued to pump oil in much larger volumes than the officials of the country formally promised. Mikhail Krutikhin, partner of RusEnergy, a Moscow consulting company, told me about his conversations with Russian oil companies. He remembered asking them: “How do you manage to fulfill OPEC + requirements?” “We continue to mine and pretend that we do not mine,” they replied laughing.

Many leaders in Moscow — especially Igor Sechin, Putin’s longtime friend and head of Rosneft, the state-owned giant oil company — were generally against any cuts in production under the OPEC + agreement. Logically, by agreeing to limit oil production, Russia was depriving itself of potential income. And in the United States, due to high prices, the production of shale oil was economically feasible, and American producers of shale oil, not bound by obligations under the OPEC + agreement, could produce as much as they wanted. Sechin also had personal reasons to object to the reduction in production: he wanted Rosneft to develop new ambitious and capital-intensive oil fields in the Arctic, but so far the company was limited in its actions by OPEC + rules, the implementation of these projects was impossible.

Regardless of whether Russia acted in good faith or not, at first the OPEC + agreement was beneficial to it: within three years, the agreed production cuts brought Russia additional revenues from the sale of hydrocarbons in the amount of $ 120 billion. But since at the beginning of this year, demand for oil, and with it prices, began to fall, the understanding underlying the agreement, allowing for connivance, replaced the economy based on sober realism. In early March, Saudi Arabia demanded that the parties to the OPEC + agreement further reduce production by one and a half million barrels per day.

Amid falling prices, Crown Prince Mohammed bin Salman and other influential figures in the Saudi Arabian energy industry were less inclined to turn a blind eye to Russia’s not-so-strict compliance with the agreement to reduce production jointly. Later, the parties accused each other of balancing on the verge of permissible, and the confrontation began: either Russia will agree to further production cuts, or the OPEC + agreement will be broken and its participants will produce as much oil as they want.

By this time, the consequences of the spread of COVID-19 coronavirus in China had already had a negative impact on the supply chain and contributed to a decrease in global economic production. To the Kremlin, limiting production in order to maintain high prices seemed to be pointless or at least ineffective. “We cannot deal with the situation of falling demand when the bottom is not obvious and unclear where it is located,” Pavel Sorokin, Deputy Minister of Energy of Russia, said in an interview with Reuters.

Sechin chose the right moment to appeal to Putin again, sending him a personal letter (a copy of which was at the disposal of Reuters), in which he claims that the OPEC + agreement creates a “preferential advantage” for the United States and, thus, , poses a “strategic threat” to Russia. In addition, Sechin allegedly told Putin that Russia should strike at the American shale industry and the Saudi budget “at the most painful moment” — that is, when oil demand is already falling.

The last straw, perhaps, was a clash on a personal basis between Muhammad bin Salman, known for his courage – or rather recklessness – and Putin, who most of all in the world does not like when he is driven into a corner. “Putin does not tolerate the language of ultimatums,” said Vladimir Milov, who previously held the post of Deputy Minister of Energy of Russia, and is now an opposition politician close to Alexei Navalny, the country’s leading leader in the anti-Putin opposition. “As I imagine it, the Saudis tried to put pressure on us, and Putin sent them to hell.”

On March 6th, at a meeting in Vienna, representatives of Saudi Arabia and Russia could not come to an agreement. “The negotiations ended, everyone slammed the door,” said Fyodor Lukyanov, editor of the journal Russia in Global Affairs and a famous figure in Moscow’s foreign policy circles, in an interview with me. Saudi Arabia responded not only with the fact that it began to extract oil in the volumes that existed before the conclusion of the OPEC + agreement, but also with the fact that it threw an additional two million barrels to the market at a very favorable price. In one day, oil prices fell by 30%, and the ruble fell by 10% against the dollar. Nevertheless, in the early days of March, the prevailing opinion in Moscow was that Saudi Arabia would have to give in first. “They will feel bad, and we will be able to hold out,” said Lukyanov, describing the mood that existed then.

This confidence depended on the price of oil at which each country’s national budget is balanced. For Russia, this figure is 40-45 dollars per barrel, for Saudi Arabia – 80-85 dollars. However, this calculation does not indicate that Saudi Arabia’s high figures are based on ambitious and expensive projects such as the Saudi Vision 2030 strategic development program (“Vision of Saudi Arabia 2030”) aimed at reducing the country’s oil dependence. And the oil prices laid down in the Russian budget are what the state really needs to operate without deficit. If necessary, Riyadh could limit or even abandon its excessive costs and at the same time remain relatively prosperous.

At the same time, there was no clear idea that low prices would destroy American shale oil producers. In general, shale oil production is profitable at prices of about $ 50 per barrel. But, unlike such inflated state-owned companies of giants like Rosneft, there are many companies operating in the American shale sector, and those that do not go bankrupt are able to minimize for a while and even stop production, and then – if / when prices grow up – increase it again. Putin and Sechin bet that Russia could bring down the oil sector of Saudi Arabia and the United States, holding out longer than each of these countries through a combination of resources (Russia has accumulated more than $ 560 billion in sovereign reserve funds), perseverance, fortitude and just courage.

Although this seems bold and risky, it is possible that Russia felt that it had several better options. The OPEC + agreement was losing its significance, and no real volumes of production reduction could change it. Under these conditions, Russia’s decision to abandon further reductions “seemed quite reasonable,” said Ekaterina Grushenkoko, an oil expert at the Energy Center of the Moscow School of Management Skolkovo. But the unexpected global spread of the coronavirus COVID-19 soon dramatically changed the mind in Moscow and other countries. “Whatever logic is there, it has lost relevance as soon as the virus has spread around the world,” she said in an interview with me.

The price war hit global oil markets at a time when the pandemic was gaining global proportions. Almost all the major economies in the world were in one form or another “stopped.” In conditions when enterprises are closed, there are no drivers on the roads, and trade ceased, oil demand fell to a record level. Oil markets eventually collapsed under the simultaneous influence of two factors, each of which was more powerful than Russia expected. This is, firstly, about the oversupply, which turned out to be sharper due to the dumping undertaken by the Saudis, and, secondly, about the COVID-19 pandemic, which resulted in an unprecedented economic chaos. “During a war, it’s better not to fight on two fronts at once,” said Andrei Baklanov, the former Russian ambassador to Saudi Arabia, in an interview with me.

Putin and his advisers hoped that Russia could survive the long period when oil would cost $ 40-45 per barrel, although they boasted that they could hold out even at the oil price of $ 25-30, at which oil was sold last month. But if everything went on as before, the price of oil could fall even lower – according to some forecasts, to $ 15-20 per barrel. According to Grushovenko, in comparison with the pre-crisis situation, an uncontrolled price war could lead to the fact that the Russian budget would not receive about $ 100 billion in 2020.

Baklanov believes that although the OPEC + rules, which gave American shale oil producers advantages, may have been “unfair and erroneous,” the medicine turned out to be more dangerous than the disease. “Destroying the market, and with it dropping prices, to teach a lesson to those who behave badly is a dangerous policy,” he said. As for those who pushed Russia to such a confrontation, “their logic is clear, but they turned out to be naive.”

Putin found himself in a difficult situation for another reason: the number of cases of COVID-19 in Russia grew exponentially and reached more than 20 thousand. And he decided not to carry out clearly defined events throughout the country. The country found itself in conditions in which there are no uniform requirements for the regime of isolation and closure of enterprises, and each region is formally responsible for establishing quarantine, and if so, how strict and on what scale. Putin and his advisers also decided not to use Russia’s huge oil reserves to support the economy.

“They are afraid of future shocks, whether in the oil markets or as a result of the global recession, and do not want their reserves to be spent before a new wave begins,” said Vladimir Milov. But it is expensive for both the economy and health care. Considering, that there are no special funds from Moscow intended to finance events in emergency situations, the regions do not have money to afford long quarantines. “They are forced to choose between quarantine and the economy,” said Milov.

Unwilling to use Russia’s financial reserves in a pandemic and constantly falling oil prices, Putin is now inclined to make a deal. His change of mood coincided with the fact that bin Salman and Trump, whose economies also had problems, began to act more aggressively. Putin pursued another goal – he wanted the United States to become a member, part of global mechanisms to curb oil prices, and not be a country that has undeservedly enjoyed advantages. The position of Russia, Lukyanov explained, is that “the United States must take part in the agreement and assume some obligations.”

In this sense, given the fact that the United States has now become a participant in world oil policy, the agreement has become minimally acceptable for Russia. Trump said that the United States will reduce production, even taking on some of Mexico’s obligations to limit oil production.

However, the details of the agreement indicate that it is dangerous for Russia. Both Russia and Saudi Arabia will cut oil production by two and a half million barrels per day, which is much more than the reduction of five hundred thousand barrels that Putin abandoned last month. According to the old OPEC + agreement, Russia actually produced a million barrels more than Saudi Arabia. Now both countries will produce the same amount. Moreover, none of the obligations of the United States was formulated specifically – and it is quite possible that as the United States fulfills the terms of the agreement, the natural decline in US production due to falling prices will be taken into account. According to Krutikhin, Russia, one way or another, was destined to withdraw from the OPEC + agreement, but she had to do it “gradually and peacefully, without such a scandal.”

In an interview with RBC’s Moscow business news channel, Leonid Fedun, vice president of the largest Russian private oil company Lukoil, compared the deal to Brest Peace, when the Bolsheviks in 1918 were forced to … make a deal with Germany that was humiliating and difficult.

Perhaps Russia can be reassured by the fact that the very concept of a cartel may soon become obsolete. The goal of the Sunday agreement is to reduce global production by 10%, and coronavirus-related shocks, according to preliminary forecasts, will reduce demand by 30%. If even the most promising oil deal in modern history is unable to keep prices from falling, then what other way can they be kept?

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