Geopol­i­tics of oil takes new twist

The Pak Banker - - OPINION - Liam Hal­li­gan

WHAT are we to make of last week's deal to freeze oil out­put be­tween Saudi Ara­bia and Rus­sia - the world's two lead­ing crude ex­porters? Is it sig­nif­i­cant and is the price of oil now likely to rise? This agree­ment is re­mark­able in the sense that there typ­i­cally isn't much love lost be­tween Riyadh and Moscow. While Saudi has tra­di­tion­ally been the beat­ing heart of Opec, Rus­sia has al­ways sat staunchly out­side the 56-year-old oil ex­porters' car­tel, just like the Soviet Union be­fore it. The fact that the Desert King­dom has long been a US-ally (al­beit to vary­ing de­grees) has also helped stoke Russo-Saudi ten­sions.

With Chi­nese oil de­mand dou­bling over the past decade and Rus­sia us­ing its geo­graphic prox­im­ity to build pipe­lines and lu­cra­tive long-term sup­plies deals with Bei­jing, eat­ing in Saudi's global mar­ket share, the ri­valry be­tween th­ese two en­ergy gi­ants has lately in­ten­si­fied. Most re­cently, of course, they have been on op­po­site sides of the Syr­ian civil war, with Saudi and Turkey back­ing op­po­si­tion forces, while Rus­sia and Iran have propped up the regime of Bashar al-As­sad. De­spite all that, we've just wit­nessed the most sig­nif­i­cant oil sup­ply deal since Saudi an­nounced that Opec would raise pro­duc­tion into the face of fall­ing prices in 2014 - a move specif­i­cally de­signed to drive prices down fur­ther and knock up­start yet high-cost US shale pro­duc­ers out of the mar­ket. Hav­ing watched crude fall 70pc in just 18 months, and with a bud­get deficit close to more than 15pc of na­tional in­come, Saudi's pow­er­ful oil min­is­ter Ali al-Naimi is now putting down a marker. "Freez­ing at the Jan­uary level [of pro­duc­tion] is ad­e­quate for the mar­ket, we be­lieve," al-Naimi said last week.

"We recog­nise sup­ply is go­ing down be­cause of cur­rent prices and we also recog­nise de­mand is on the rise." The Rus­sian govern­ment, too, while less de­pen­dent on oil rev­enues than Saudi, will also be re­lieved if crude prices sig­nif­i­cantly rise. The first thing to say about this deal, which also in­cluded Opec-mem­bers Venezuela and Qatar, is that, de­spite rep­re­sent­ing a ma­jor diplo­matic de­vel­op­ment, it's far less im­por­tant in terms of oil sup­ply than it ini­tially seemed. The agree­ment was to main­tain pro­duc­tion at Jan­uary lev­els, rather than cut, and it so hap­pens that among the two main sig­na­to­ries last month's out­put was al­ready sky-high.

Rus­sia pumped 10.9 mil­lion bar­rels a day in Jan­uary, a post-Soviet record, while Saudi pro­duced 10.2 mil­lion bar­rels, the high­est Jan­uary level in 35 years. Far from a pro­duc­tion lim­i­ta­tion ex­er­cise, then, this was more of a com­mit­ment to keep crude flow­ing at max­i­mum ca­pac­ity. On top of that, "quota-cheat­ing" (al­ready ram­pant within Opec, as cash­strapped gov­ern­ments over-pro­duce to garner ex­tra rev­enue) could be even worse given this deal goes be­yond the car­tel's mem­ber­ship.

Yet oil ral­lied al­most 10pc when this un­ex­pected Saudi-Rus­sian dé­tente hit the news wires. Prior to that an­nounce­ment, there was no inkling talks were even tak­ing place. We saw fur­ther price rises on Thurs­day, af­ter Iran "en­dorsed" the move by Riyadh and Moscow to cap pro­duc­tion, with crude ris­ing al­most 15pc over two days.

Com­mod­ity price bulls were fur­ther boosted by re­ports that US crude stocks were down last week, fall­ing 3.3 mil­lion to 499.1 mil­lion bar­rels, com­pared to mar­ket ex­pecta- tions of a 3.9 mil­lion-bar­rel rise. Hav­ing said that, it soon be­came clear that Iran, de­spite be­ing in Opec, will not limit its own oil out­put. That would be "il­log­i­cal", the Ira­nian govern­ment dis­closed, given that the coun­try has just re­gained ac­cess to in­ter­na­tional mar­kets. Prior to sanc­tions im­posed in 2012, Iran ex­ported 2.5 mil­lion bar­rels of oil daily, with in­ter­na­tional re­stric­tions cut­ting ship­ments to 1.1 mil­lion bar­rels to­day.

Now sanc­tions are be­ing lifted, Tehran is de­ter­mined to re­gain some of its global mar­ket share. That re­al­ity, com­bined with an­cient en­mity to­wards the Saudis, makes it dif­fi­cult to imag­ine Iran cap­ping its own oil ex­ports, let alone agree­ing to an Opec-wide cut.

Some­thing needs to give, though, be­cause Riyadh is clearly get­ting des­per­ate. The fact that Saudi and Rus­sia are even talk­ing and an­nounc­ing any kind of deal - the first be­tween a mem­ber of Opec and a non-mem­ber for 15 years - sug­gests that Riyadh's re­solve is weak­en­ing. The coun­try burnt through a stag­ger­ing $120bn of re­serves dur­ing the last two months of 2015, a stom­achchurn­ing 16pc of the de­clared to­tal. US-based rat­ings agen­cies piled on the pres­sure last week, with Stan­dard & Poor's slash­ing Riyadh's sov­er­eign debt rat­ing an­other two notches for the se­cond time in five months. There is in­creas­ing chat­ter in the mar­ket the Saudi au­thor­i­ties may have to aban­don the riyal's peg to the dol­lar, lead­ing to a de­pre­ci­a­tion that could pro­voke political un­rest.

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