Crude Economics
Russia Ready to Talk Oil Cuts with OPEC

When Leonid Fedun, the vice president of the Russian state-owned oil company Lukoil, said earlier this week that he thought that, if Moscow assented, “Russia should jointly work with OPEC to cut supply to the market,” we pointed out that embarking on such a strategy would be Putin’s decision, not one of his oligarchs. But now, Russian energy minister Alexander Novak is admitting that Moscow is willing to entertain the idea of joint production cuts with OPEC, and is looking to set up a meeting next month. The Telegraph reports:

Forward contracts for Brent crude soared as high as $35.85 on Thursday after Moscow’s oil minister Alexander Novak said his government was willing to engage in “coordination” with Opec [. . .]

“We had these sorts of consultations before, when the situation was somewhat different. As we see, prices have fallen,” Mr Novak told the Interfax news agency.

Novak suggested that the proposal up for discussion would be a 5 percent cut in output from both Russia and OPEC, which according to the FT  “would remove more than 2m barrels at day of production and help rebalance an oversupplied market.” As the quote above notes, the market has already responded, with Europe’s Brent crude benchmark spiking more than five percent in trading earlier today before erasing some (but not all) of those gains and settling now above $34 per barrel.

This talk points to the reality that Russia badly needs prices to go back up. But conditions currently don’t look very favorable: U.S. shale producers have surprised analysts with their resilience in the face of cheap prices, and Iran is ready to ramp up its own production as Western sanctions are lifted. Moreover, Russia can’t keep Iran from following through on that eagerness to raise output to pre-sanctions levels as quickly as possible—and it wouldn’t want to, anyways, for concern over what it would do to the two countries’ relationship.

Therefore, Moscow’s prime target has to be Riyadh. Unable to stop Iran, Russia hopes to erode the Saudi determination to keep the product pumping no matter what it does to the price. But for its part, though Riyadh has followed a strategy that’s been motivated by the hope of undermining Iran, Tehran’s ally Iraq, and U.S. shale producers, punishing Moscow is a feature, not a bug, of its approach. Realistically, then, there is no way the Russians could get the Saudis to even think about cutting production unless Moscow is also willing to accept some limits on its own production—hence this newfound willingness to discuss ceding its ever-important market share.

Taking all this into account, it’s nevertheless hard to say right now if all of this noise is just squeals of pain or is part of a serious strategy. We do know that there exists an axis of hawks within OPEC that would fight for a price rise, and as we’ve seen today, just talking about a meeting raised prices a little. So, Moscow might think, why not set up a meeting with the cartel—especially given how bad it is hurting? On the other hand, consensus still won’t be easy to reach, especially with Iran so keen to quickly regain its oil exporting clout that was hit by sanctions.

And then there’s the U.S. As Russia and OPEC maneuver in response to the prolonged glut, the U.S. should be thinking ahead. If we had a president interested in playing the game, he’d be looking for ways to strengthen the shale industry right around now, perhaps by reducing licensing fees or opening up more production on federal lands, as a way of underlining the message that U.S. production will indeed rise when prices do.

Keep in mind that shale producers have amassed an enormous “fracklog” of drilled but not yet completed wells ready to start producing the minute that prices return to levels that make it profitable to do so. Even if the petrostates of the world manage to reach an agreement to scale back production, upstart American producers will be there to blunt the impact of any significant rebound.

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