Economic gains associated with the Gulf reconciliation will be narrow and limited, and any economic momentum should be channeled to tackle longer-term challenges in the region.
The aftermath of what was expected to be a successful OPEC+ meeting in early March was not a pretty sight. Oil prices fell by over one-third, Gulf markets lost a collective $400 million, and the shares of Russian energy companies and their banking partners fell by 10% to 25%. This “energy Armageddon” is further convulsing global markets already reeling from the spread of the coronavirus to Europe and the United States.
Saudi-Russian intransigence may have been a product of a “coronavirus-instigated meltdown” in China. Where China accounted for two-thirds of global oil demand growth in 2019, demand has now shrunk by 20% due to the impact of the coronavirus on business activity and consumer spending. In this regard, fierce competition between Saudi Arabia and Russia, the top two crude oil suppliers to China, for a shrinking market led to the rupture of OPEC+, the group of OPEC and non-OPEC producers. Several Chinese refineries, for example, have reduced their demand for Saudi crude. Different assessments of China’s ability to recover from the coronavirus also hindered a new OPEC+ agreement. While Saudi Arabia pressed for urgent and deeper production cuts, Russia was more sanguine, with a senior Russian oil executive noting that “something happens every month on the oil market and if OPEC+ reacts to changes every month, this will only lead to destabilization of the situation. Therefore, it’s better to observe and probably decide on quotas a little later.”
In actual fact, Saudi-Russian competition over China was already in full swing prior to the coronavirus outbreak. Saudi Arabia, China’s top oil supplier, had routinely exported two to three times more oil than Russia. Between 2015 and 2018, however, Russia supplanted the kingdom. This was largely due to China’s oil-for-loans program with Russia and the completion of a dedicated oil pipeline to China that allowed Beijing to reduce vulnerability to seaborne oil imports. In 2019, both oil exporters competed to woo refineries in China so as to lock in crude oil deliveries, with Saudi Arabia regaining its lead over Russia. This rivalry has also been replicated in other Asian markets, such as India.
U.S. Shale Oil
Saudi Arabia and Russia have also diverged over how to deal with U.S. shale oil. Accounting for almost two-thirds of U.S. oil produced, shale oil has propelled the United States’ rise as the world’s largest oil producer and the eighth largest oil exporter. Under a business-as-usual forecast, the shale revolution would, by 2024, result in the United States overtaking Russia to become the world’s second largest oil exporter, while OPEC’s share of global oil supply would be reduced to 31% from 35% in 2014.
For Russia, shale is “barbaric” on several counts. It has lowered oil prices by $10 per barrel to $50/bbl and resulted in billions of foregone revenue. Shale has also provided Russia’s geopolitical nemesis with more freedom to maneuver in foreign policy. Whereas the United States was previously reluctant to act against petro-states since it was dependent on imported oil, it is now much less constrained. In this regard, U.S. sanctions have hurt Russia directly – around 0.8% of gross domestic product, or $60 billion, was lost in economic growth over four years – and through its interests in Iran and the Nord Stream 2 pipeline. U.S. shale oil and gas are also making inroads in Europe, the destination for 70% of Russia’s crude oil and two-thirds of gas sales. For Moscow, bankrupting shale oil producers through a price war seemed a more effective, if drastic option; the constraints on production limits imposed by OPEC+ therefore had to be eliminated.
In contrast, Gulf Arab states are perceived to have enabled the shale boom with investments in U.S. refineries, direct stakes in U.S. shale operations, and importing the technology to produce their owntight gas reserves.
Backlash Against OPEC+
For over a year, various groups in Russia have stepped up pressure to seek the country’s exit from OPEC+, including leaders of energy companies keen to raise output and quickly develop new projects. For economic nationalists, Russia is now in a much stronger financial position than it was in 2016 to challenge shale oil producers without OPEC’s help. With a budget that balances with oil at $42/bbl, cash reserves that exceed its debts, and a freely floating ruble-dollar exchange rate, it may be able to withstand more pain from the collapse in oil prices than other producers. For Saudi Arabia, should Brent crude remain below $40, the kingdom’s net foreign reserves to cover growing fiscal deficits could be exhausted in about five years without any adjustment in spending. There is also a sentiment that cooperation with OPEC had not translated into enough broader economic benefits for Russia. In return for signing up to OPEC+, Moscow had expected the Gulf states toincrease investments into a Russian economy hobbled by U.S. and European Union sanctions.
As for the Gulf states, Russia’s low level of compliance with cuts mandated by OPEC+ has been a quiet source of tension. They were politely described as being “confused” with Russia’s commitments, particularly since Saudi Arabia was shouldering a significantly larger burden of production cuts than Russia.
Future of Russian-Gulf Ties
Russian-Gulf ties have been shaken by the failed OPEC+ meeting. Both sides have threatened to flood the market with more oil to see who blinks first from the pain of lower oil prices. Cooperation in global energy markets, however, is only one pillar of Russian-Gulf ties. There are also common interests regarding political extremism, regional conflicts, and trade and economic development. Consequently, predictions of a breakup may be premature. For instance, the fraught Russian-Turkish relations over Idlib suggest that Russia’s attempts at a political settlement in Syria will require buy-in and support from Gulf states.
Furthermore, 2020 is not 2016. Shale producers have repeatedly proved resilient. The most indebted may not weather the current round of low oil prices but deep-pocketed international oil majors could eventually acquire and turn around survivors. Furthermore, low oil prices are unlikely to be a simple fillip to economic growth. While depressed demand conditions are partly the result of the coronavirus outbreak, in some cases, such as China, demand had already begun slowing. In other words, Russia’s go-it-alone approach may have limited impact in these conditions. As for Gulf states, a prolonged depression in global demand, travel, and consumer spending will challenge carefully laid plans to diversify away from oil.
The way back for Russia, the Gulf states, and OPEC+ may rest with the United Arab Emirates and Oman. Leveraging the Gulf’s only Declaration of Strategic Partnership with Russia, the UAE has tried to reduce the distance between Russian and Gulf policies over Syria and Libya. Saudi Arabia, for instance, turned to the UAE to sway Russia in favor of deeper production cuts. Oman could also draw upon its niche role as a regional mediator. With public debts that already exceed the assets of its sovereign wealth fund, it is least able to afford a prolonged period of low oil prices among the Gulf states.
The UAE and Oman can take heart from conciliatory messages by Russia and Saudi Arabia that have left the door open for a future OPEC+ agreement. Russian President Vladimir Putinhad praised OPEC+ as a mechanism that “has already established itself as an effective tool in ensuring long-term stability in global energy markets.” Going one step further, Saudi Arabia reiterated it has no intention “to wage any wars with Russia. On the contrary, Russia is still a very important partner for Riyadhand the most important player in the energy market.”But, as producers talk about ramping up oil production, time and economic pain will tell if the OPEC+ alliance is salvageable.
The new variant of the coronavirus, new lockdowns in several parts of the world, and the slower-than-expected rollout of the vaccine cast doubt on the timing of a recovery that would sustain higher production.
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