Have Secret Meetings Changed Russia’s Luck Ahead of OPEC Decision?

Mikhail Mordasov/AFP/Getty Images

Mikhail Mordasov/AFP/Getty Images

Before the November 2014 OPEC meeting in Vienna, the head of Russia’s state-owned oil company Rosneft flew to Vienna to meet with OPEC members. The meeting demonstrated Russia’s interest in stopping oil prices from falling further, as it pushed OPEC to cut back on oil production. But little came of the meeting, since Russia was not prepared to participate in any decrease in output.

With OPEC set to meet again on June 5, the Wall Street Journal reported that Russian officials again held secret discussions with OPEC. Once again, the meeting, apparently held on May 13, concluded without any agreement.

Russia is overwhelmingly dependent on oil. Around half of its budget revenues come from oil and gas, and for this reason Russia is particularly desperate to see a return to higher oil prices. A disproportionate dependence on oil revenues is something shared by most, if not all, of the members of OPEC.

But the two sides are operating in different circumstances. For example, the de facto head of OPEC, Saudi Arabia has a vast war chest, somewhere on the order of $700 billion in reserves.

Ultimately, however, the big difference is that Saudi Arabia plays the long game. There are multiple concerns in Riyadh that factor into its strategic decision making over oil output. The near to medium term concern is maintaining market share, which it is pursuing by keeping oil production levels high. Saudi Oil Minister Ali al-Naimi said on June 1 that the strategy was working, and with an eye on stagnating U.S. shale production, he said the markets are moving “in the right direction.”

But a longer-term concern for Saudi Arabia is the stability of demand. Europe and the U.S. have already achieved extraordinary gains in vehicle efficiency, resulting in a plateau in oil demand. But a serious effort on climate change, which would necessarily entail stringent policies targeting oil consumption, could much more significantly erode Saudi Arabia’s customer base over time, with little chance of returning once it is gone.

That means Riyadh has a very strong incentive to delay that transition to cleaner fuels. Flooding the market with oil and causing prices to crash does allow OPEC to capture back some market share from U.S. shale, but it also undermines the case for alternatives to oil, pushing back the ultimate day of reckoning.

Russia, on the other hand, has more immediate concerns. With the ruble having tumbled over the past year, and budget revenues drying up from a combination of western sanctions and the collapse in oil prices, Russia is playing the short game. It would like to see oil prices rise, obviously, and has pressed OPEC to cut back. But it is unwilling to slash its own output. In May, Russia pumped 10.7 million barrels per day, a 1.6% jump from the same month in 2014.

But, what would it look like if Russia and OPEC could actually overcome their mutual mistrust and actually coordinate production levels? OPEC has set its quota at 30 million barrels per day, controlling a little less than a third of global supplies. If Russia joined in, that would push the combined group’s total output over 40 million barrels per day, capturing more than 40% of the global market. With that higher level of control, they could have much more sway over prices – production cuts would have a much stronger effect on prices if the two sides worked together.

With that said, there is little to no chance that such a scenario will come to pass. In the past, Russia has promised OPEC that it would cut output, only to do the opposite. Although OPEC would like to see Russia come to the table and coordinate, its members are not naïve. Moreover, the Wall Street Journal reported that Saudi Arabia, Kuwait, and the United Arab Emirates aren’t interested in meeting with Russian officials in Vienna this week. That suggests they have little faith that Russia will offer anything substantive, but it also indicates that the group has made up its mind to play for market share – i.e., keep production levels unchanged.

That leaves us back to where we were six months ago. OPEC will not alter production, and neither will Russia. The battle for market share continues. That is ultimately bad news for U.S. shale.

 Originally written for OilPrice.com, a website that focuses on news and analysis on the topics of alternative energy, geopolitics, and oil and gas. OilPrice.com is written for an educated audience that includes investors, fund managers, resource bankers, traders, and energy market professionals around the world.

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