Oil output cut deal result of back-door diplomacy
Despite an unpleasant history, the output cut deal between Riyadh and Moscow appears sticking. Months of back-door energy diplomacy, at the highest level, helped overcoming the lack of trust between Russia and Saudi Arabia.
Moscow has been accused of failing to keep its commitments several times in past. A Platts report highlights Russia’s renegade on its commitments with Opec in March 1998, March 1999, November 2001, December 2001 and as recently as November 2014.
With the Russian Ministry of Energy continuing to maintain the same forecast on production growth, with total output in 2017 to reach 548-551 million tonnes (11.01-11.07 million barrels per day), questions persist about Russian intentions. Some also suggest the offer to reduce supply by 300,000 bpd basically portrays natural declines from its older fields.
Things but appear different — this time. The Russian government, including President Putin himself, have made a substantial reputational commitment to making the deal work. As per press reports, the agreement follows almost a year of petro-diplomacy that led Russian President Vladimir Putin and Saudi leaders putting aside their differences over the war in Syria as their economies struggle to adapt to the halving in oil prices since mid-2014.
The deal involved direct talks between Putin and his Saudi and Iranian counterparts, while the breakthrough reportedly came from a late night phone call between the Russian and Saudi oil ministers. “Negotiations from technical to leadership went on for a year with meetings in Russia and elsewhere,” one Opec delegate was quoted as saying.
The involvement of Putin, who has held talks this year with Saudi Deputy Crown Prince Mohammed bin Salman, adds weight to Moscow’s commitment.
Ronald Smith, Citigroup’s senior Russian oil and gas analyst, is of the view that the maths of higher prices versus lower production also adds to the impetus to the Russian government to follow up on the commitments. This is based on the fact that oil taxation has traditionally provided almost half of the country’s tax revenue and because the Russian oil tax regime is highly geared to the price of oil.
For example, extraction taxes and export duties combined go up $8.30 per barrel for every $10 rise in oil prices. The net effect of a 300,000 b/d output cut and a $10 oil price increase would be a 28pc increase in oil tax revenues in US dollar terms, and 15pc in local currency terms, giving a material boost to the Russian government’s efforts to balance its budget.
As for Russia’s ability to cut output and questions about the Kremlin’s legal authority to dictate production levels, while the government may lack formal control over output, it has substantial informal influence over the industry, the Citigroup’s analyst believes.
And then answering the question, why would Russian independent producers voluntarily reduce output, Smith thinks most Russian oil companies have at least some older fields that are at best marginally profitable, with economic rents predominantly going to the government as taxation. One large Russian oil company estimated in March that “over 30 per cent” of its producing fields were uneconomic.
While this could partly be due to the low oil prices at the time, it also lends credence to suspicion that there may be a material amount of Russian production that remains on-line to generate tax revenues for the government than profit for the producing company, the analysis added.
Hence after a meeting of 12 oil producers that account for around 90pc of Russian output, Energy Minister Alexander Novak told reporters: “We agreed that the reduction will be in proportion to the production volumes (of each company).”
Novak though reiterated that the cuts will be voluntary for each company and that there would be “separate discussions” on production-sharing agreements involving a number of foreign energy companies, including ExxonMobil.
Saudi Arabia and Russia today together account for more than a fifth of global oil supplies. The first global crude supply pact in 15 years is underlining the growing energy amity between Saudi Arabia and Russia, “It is very significant to have an agreement by the two powerhouses that are Russia and Saudi Arabia,” said Olivier Jakob, analyst at the Petromatrix consultancy.
A new geopolitical dynamics is being created and it has the potential to transform the global oil markets.