Oil prices rose again sharply this week after Opec got non-Opec countries to add 558,000 barrels per day of cuts to the 1.2 million bpd, which Opec agreed to on November 30. The agreement looks solid enough for some analysts to raise next year’s Brent estimates to US$60-70 per barrel.
Khalid Al Falih, the Saudi Arabian oil minister, added a fillip to the formal commitment Russia, Mexico, Kazakhstan, Azerbaijan, and Oman made in Vienna on Saturday. He promised to “cut substantially to be below the level we have committed to on November 30”. This would take Saudi production under 10 million bpd, down perhaps 550,000 bpd from the October reference level of production.
The kingdom is the driving force behind a deal that has been in the works for the best part of 2016 and Mr Al Falih pointed out over the weekend that he had been in numerous talks, many of them private, with Alexander Novak, Russia’s energy minister, who spearheaded a spring initiative to achieve cuts to balance the oil market.
Both countries are the largest crude producers, with Russia slightly ahead at an October reference level of 11.2 million bpd. They saw it in their mutual interest to coax others into an accord on the logic that prices in the $50s would more than offset the relatively small cuts in production needed to keep prices from returning to the $30s next year.
Saudi-Russian cooperation was cemented at a very high level when president Vladimir Putin took advantage of a September G20 Summit in China to meet discreetly and privately with Prince Mohammed bin Salman, the deputy crown prince. They agreed to work together to get an agreement and Mr Putin played a key role ahead of the November Opec meeting in persuading the Iranian president, Hassan Rouhani, to sell a compromise to Iran’s supreme leader, who was refusing to accept a quota while the country recovered production and sales after the lifting of the UN embargo.
The Russian president had seen clearly the effect of low oil prices on the rouble and the declining economy. Moreover he is also keenly aware of the knock-on effect on natural gas prices, which over the past year had gone much lower due to pricing formulas indexed to oil.
In fact, Russia is probably the biggest beneficiary of the agreement when the effect on combined oil and gas revenues is taken into account. So there was not much doubt that Russia would officially sign up on Saturday for the 300,000 bpd pre-agreed cut that Opec’s president, Mohammed Al Sada, also Qatar’s energy minister, announced at the end of the Opec meeting itself.
Firmer oil and natural gas prices will reverse the fortunes of the Russian economy, which has contracted for seven consecutive quarters so far under the influence of tumbling oil prices. Higher prices will probably reverse this trend, but Mr Putin is highly motivated to ensure the Vienna agreements continue to hold and pull Russia out of its economic malaise next year.
The Russian leader wants to be able to demonstrate economic success ahead of spring 2018, when he faces presidential elections that could extend his term in office until 2024.
It is slightly ironic that there is likely to be similar timing on the event that has galvanised Saudi Arabia to act in concert with Russia, which has been a political foe in the Middle East. The initial public offering of Saudi Aramco is scheduled for 2018.
It will be the biggest IPO ever, valuing the company at perhaps $3 trillion. But although the refining and other assets will be included, the main asset is the company’s massive petroleum reserves. The valuation of oil in the ground depends critically on future price assumptions because that value will be estimated as the discounted present value of future production.
A valuation when the average price is $40 and fluctuating wildly will be quite different from one where oil is $60 and stable. In the former case, Riyadh might even be compelled to withdraw the offering because it does not achieve the minimum market valuation of $2tn, which the Saudi rulers seem to have in mind.
The Aramco IPO underpins the whole “Vision 2030” for the Saudi economy, the ambitious plan to diversify the economy away from oil. Already, under the influence of low oil prices, the huge solar electricity initiative has been delayed by almost a decade.
Economically much of the Saudi plan hinges on higher, and stable, oil prices than those that prevailed in 2015 and this year, when prices bottomed in the $20s in January. But even the price war itself may have reflected Saudi concern over oil revenue because things seemed in 2014 to be moving in the direction of the 1980s when Saudi production was gradually cut back by more than 60 per cent to a low of 3.6 million bpd in 1985, while the top priority was defending the Opec price.
A repetition of this would clearly have been disastrous for Vision 2030 and the Aramco IPO. It is clear why the first stage of the Saudi strategy had to be defending its market share and former Saudi oil minister, Ali Al Naimi, who had been through the drastic shrinkage of the 1980s within Saudi Aramco, knew he could not afford to let US shale oil and other high-cost sources gain any more market share when he changed Saudi policy abruptly in 2014.
But now, with the second stage of the Saudi policy aimed at stabilising prices at higher levels with production at about 10 million bpd, the current Saudi energy minister realises that enforcing the new agreements will be critical to the success of his new plan.
This is the reason Opec is seeking to buttress its revived Ministerial Monitoring Committee, on which Russia will also sit, with strong independent sources, such as Petro-Logistics, that monitor tanker movements and a variety of oil flows around the world by satellite and other means.
There cannot be much slippage in the 1.75 million bpd of cuts committed if the 700 million barrel increase in inventories since mid-2014 is to be mopped up. Part of the increase is new Chinese strategic storage but huge supplies acquired at lower prices will still have to be worked off.
Still, the signs are good that the producers have a solid pact. Even Iraq, which was widely expected to cheat, is exploring ways of cutting, with its oil minister, Jabar Al Luaibi, already in discussion with the major oil companies rehabilitating southern oilfields about how reductions might be dovetailed with the secondary water injection programme, which the IOCs had been delaying due to low oil prices.
Already the UAE is leading Arab Gulf producers on the new policy, with Adnoc announcing that export grades will be trimmed by 3 to 5 per cent.
Nevertheless, only time will tell how successful Russia and Saudi Arabia might be in their joint initiative to stabilise prices for their mutual economic benefit and political ends. But it is also worth observing that Moscow (and possibly other oil capitals) have deeply parallel interests because Mr Putin has in mind his legacy with plans to privatise Rosneft and other state holdings in energy where valuations will be equally affected by the oil price.
It is to be hoped that the cooperation in the oil market might be a portend of happier times in the Middle East if the dialogue can be extended to the political sphere to achieve a just peace in Syria and elsewhere.
Jim Crawford is the managing director of Sharjah-based Inter Emirates General Trading Company and a former petroleum investment banker in Canada
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