Much has been made of President Vladimir Putin’s recent claim that crude oil prices are acceptable at present levels, and the Russian economy could even weather $40 per barrel. Many oil market “tea leaf readers” have taken this to mean that Putin has caved to the demands of his country’s oil oligarchs and Russia is unlikely to agree to an extension of last December’s OPEC+ deal at the scheduled mid-year meeting.
In reality, the crafty old Russian fox is probably just posturing to get a better deal for his country at the upcoming meeting. The Kremlin needs higher crude prices than Putin claims for economic and geopolitical reasons. Why else would his government had agreed to the two previous rounds of OPEC+ cuts when crude prices were relatively low? But Saudi Arabia has only itself to blame for Russia’s more assertive bargaining position this time around, with the Kingdom having fallen back into its traditional swing producer role due to its greater need for high crude prices.
On June 6, speaking at a meeting with heads of international news agencies organized by TASS, Putin said Russia does not need or want high crude prices. “The Russian processing industry itself is not interested in very high oil prices,” he said. “Well, the average price around $60-65 dollars per barrel is quite satisfactory, we don’t need to drive up [prices] to the top, we already have a decent margin, in terms of budget.” Putin said Russia needs only $40 per barrel to balance its budget and claimed that the country can even add to its foreign exchange reserves at this price.
Russian oil companies have been far less supportive of the OPEC+ deal sealed in December 2018 than the one that took effect at the beginning of 2016 – after a period of extremely low crude prices – with oil-giant Rosneft leading the charge. In a letter to Putin in February, and seen by Reuters, Rosneft head Igor Sechin warned the latest deal posed a strategic threat to Russia as it simply opens the door for more U.S. oil. “Does it make sense (for Russia) to reduce (oil output) if the U.S immediately takes (our) market share?” Sechin was quoted as saying on June 4 by Interfax news agency in response to a possible extension of the latest OPEC+ deal. “We have to defend our market share.”
But Russia is not as bulletproof to another oil price crash as Putin claims, especially when one considers his geopolitical ambitions for the country. The Kremlin may be able to balance its government budget with $40 per barrel oil, but it’s highly unlikely it can do the same for its current account. The country’s foreign exchange reserves increased just $36 billion to $468 billion last year with Brent crude averaging $71 per barrel, and this is despite $8.8 billion of foreign direct investment on a net basis. As Cyril Widdershoven wrote in The Bearish Threat Within OPEC, “Putin’s dream of a Pax Russia cannot be built on $40 per barrel, not even on $60-65 per barrel.”
And the argument that Putin is beholden to the country’s oil and gas oligarchs to keep him in power, and hence must kowtow to them rather than do what he considers best for Russia, is comical. The last oil oligarch to stand up to Putin and test his power was Mikhail Khodorkovsky, former CEO of Yukos and once richest person in Russia. What happened to Khodorkhovsky and Yukos – jail and quasi-nationalization, respectively – since October 2003 is well documented. Anyways, Sechin, the most vocal critic of an extension to the OPEC+ deal, is one of Putin’s closest allies.
At the same time, if Russia was not planning to continue to cooperate with OPEC and the other nine non-OPEC participants of the production cut deal, why would it be finalizing a charter for a new organization? On May 27, TASS reported that the Russian Energy Minister Alexander Novak expects to reach an agreement on the OPEC+ charter in time for the mid-year meeting. The threat of a possible NOPEC act in the U.S. means that OPEC+ is unlikely to become institutionalized to the extent that we originally imagined, but it will almost certainly become a permanent new fixture of the world oil order. A fixture designed to counter the impact of the U.S. shale oil revolution.
Saudi Arabia, the de facto leader of OPEC, and Russia, the leader of the non-OPEC members of OPEC+, are fully aware of the potential impact of failing to agree upon an extension of the December 2018 OPEC+ deal. At a meeting in Moscow on June 10, Novak and Saudi Energy Minister Khalid al-Falih agreed that oil prices could crash below $40 per barrel without an extension, especially given a slowdown in oil consumption growth due to rising international trade tensions. Separately, but on the same day, Russian Finance Minister Anton Siluanov said oil prices could fall as low as $30 per barrel if OPEC+ production curbs are not extended.
However, it appears Putin can smell Saudi blood. It is widely acknowledged that Saudi Arabia needs significantly higher prices than Russia to balance its government budget – with $80-85 per barrel often cited – and this has contributed to far greater efforts by the kingdom to bolster prices so far this year than the Kremlin. For example, in April, before the chlorine contamination issue negatively impacted Russian production, the country had reduced crude output by 190,000 b/d, achieving only 80 percent of its agreed cuts based on International Energy Agency (IEA) data. In contrast, Saudi Arabia had slashed crude production by 820,000 b/d, representing 256 percent of agreed cuts.
Looking forward, we should expect an extension and possibly even a deepening of the OPEC+ cuts at the mid-year meeting. A deepening depends on downward adjustments to oil consumption growth projections between now and then, balanced by expected production declines in Iran and Venezuela – and possibly elsewhere, such as Libya. Relatively speaking, Saudi Arabia will likely have to bear more of the burden of cuts than Russia – greater than the current 1.4 to 1 ratio – with Putin likely outwitting al-Falih and company. The price of spot Brent should average $75 per barrel in the second half of the year, $10 more than the first half.