Talks between the Russians and the Saudis at the G20 summit in Hangzhou once again raised hopes throughout the oil industry of a Russian – Saudi agreement for an oil production freeze.
Russia, Saudi Arabia and the US are the three big oil producers, producing roughly similar quantities of oil in any given year. Of these three countries Saudi Arabia, since it is not a significant oil consumer, has the single biggest role in the oil market, a position further consolidated by its de facto leadership of OPEC – the international oil producers’ cartel – and the oil producing Gulf States.
In 2014 as oil prices began to slide, to the surprise and disappointment of many in the oil industry, Saudi Arabia refused to cut its output to create an artificial shortage in the oil market to support prices. On the contrary the trend throughout 2015 was for Saudi oil production to rise. The Saudis instead insisted that the market would eventually rebalance itself as more expensive output was shelved because of low prices.
Contrary to the expectations – and hopes – of many in the oil industry, the Saudis have stuck to this position ever since.
One particular phantom that has flickered with tedious regularity throughout this affair is the hope that if the Saudis will not cut production themselves, they will at least come to some sort of arrangement with the other big oil exporter – Russia (the US despite the size of its production being a net importer of oil) – to rebalance the market.
The original grounds for this hope were comments by the Saudis at the time of the OPEC summit in November 2014 that they would not cut production because they could not rely on the other big producers – first and foremost Russia – also doing so.
The Russians for their part have consistently said they will not cut production to rebalance the market, and that that is something for Saudi Arabia to do. They have also said that it would be technically impossible for them to cut production during the winter months since the cold weather in Russia would cause their Siberian wells to freeze. This explanation is widely ridiculed, though it is in fact perfectly plausible given the harsh conditions of the Siberian winter.
Whilst the Russians have consistently ruled out an oil production cut, they have been open to the idea of an oil production freeze, and in the first few weeks of this year talks between them and the Saudis to achieve this seemed for a time to be going well.
The background to those talks was a temporary crash in oil prices, which briefly fell to low of $25 a barrel. What however seems to have prompted these talks was a tour of oil producers in the first few weeks of 2016 by the Oil Minister of Venezuela who was furiously lobbying for an output cut on behalf of his severely cash-strapped government.
Whilst neither the Saudis nor the Russians were in the mood to talk about a production cut, the Venezuelan Oil Minister’s lobbying does seem to have prompted them to talk to each other about the possibility of a freeze.
In the event talks between the Russians and the Saudis and other oil producers appeared in April 2016 to have come to the brink of reaching agreement on an oil production freeze, with the text of an agreement prepared and ready for signature at an oil producers’ summit in Doha.
Then to everyone surprise, at the very last moment, the Saudi Deputy Crown Prince, Prince Mohammad bin Salman Al Saud, suddenly reversed Saudi Arabia’s position, and abruptly ordered the Saudi delegation – which was about to sign the agreement – home.
The Deputy Crown Prince’s reason was that Iran, whose oil industry had just been freed from the effect of UN sanctions which had previously limited its production and ability to sell oil, was in the process of bringing more oil onto the market, allowing Iran to benefit from a Russian – Saudi production freeze by capturing part of Saudi Arabia’s market share.
Underlying this of course is the ongoing geopolitical duel between Iran and the Saudis in the Middle East, which makes any agreement between Saudi Arabia and Iran on any subject, including oil prices and production, extremely difficult.
The meeting between Russian President Putin and the Saudi Deputy Crown Prince during the G20 summit in Hangzhou seems to have raised hopes amongst oil industry insiders that this time – with the Deputy Crown Prince directly involved in the talks – an agreement between Russia and Saudi Arabia for an oil production freeze to rebalance the oil market would finally be reached.
In the days that followed the meeting in Hangzhou comments by certain Russian and Saudi oil industry officials did appear to hold out the promise of an agreement for an oil production freeze. Thus Russian Energy Minister Aleksandr Novak after meeting Saudi officials in Hangzhou was reported to have said
“We have agreed with the Saudi Arabia energy minister on joint action aimed at stabilizing the situation in the oil market. We consider a production freeze the most efficient tool, concrete parameters are being discussed at the moment.”
Novak is also reported to have said that Saudi Arabia was considering freezing production for one to three months at the levels of July, August or September.
Saudi Oil Minister Khalid Al-Falih for his part is reported to have said
“I have to say all other producers are expressing interest in coordinating… with Saudi Arabia and other like-minded countries to reach a consensus. We are optimistic the Algiers meeting will provide a forum, and pre-Algiers consultations taking place bilaterally and in groups will bring us to Algiers with some sort of coordinated decisions. But the two countries agree that even if there is no consensus, we will be willing to take joint action when necessary.”
The reference to the meeting in Algiers is to a meeting of the International Energy Forum, which is due to take place later in September in that city.
In the event the joint Russian – Saudi statement on oil production and prices which appeared after the talks proved to be something of a damp squib. It contained no reference to an oil production freeze. The closest it came to discussing that possibility was in the following paragraph
“The Ministers recognizer the current challenges in the supply side of the global oil market, including major contraction of capital investments in oil extraction on a global scale, particularly in exploration, as well as mass deferrals of investment projects, which made the market, as a whole, more volatile and therefore unsustainable to both producers and consumers in the long term. There is an imperative to mitigate excessive volatility harmful to global economic stability and growth. In this regard, the Ministers noted that constructive dialogue and close cooperation among major oil producing countries is crucial to oil market stability to ensure sustainable levels of investment for the long term. Therefore, the Ministers agreed to act jointly or with other producers. In addition, the Ministers agreed to continue consultations on market conditions by establishing a joint monitoring task force to continuously review the oil market fundamentals and recommend measures and joint actions aimed at securing oil market stability and predictability.”
This is not an agreement for an oil production freeze. It is simply a statement of platitudes amounting to nothing more than a wish-list. Not a single concrete proposal appears anywhere in it, with some oil industry analysts not surprisingly calling it “all talk and no action”.
The likelihood nonetheless remains that some sort of oil production freeze – lasting however no more than a few weeks – will be agreed in Algiers, especially as comments from the Iranian Oil Minister suggest that Iran might now also be willing to join in.
No one should however expect a brief production freeze lasting no more than 3 months at most to have any significant impact on oil prices.
As I have said many times, the two factors that determine the level of oil prices are (1) monetary policy in the US, which has a direct impact on the oil price because oil is traded in US dollars; and (2) supply and demand.
An oil production freeze of a few weeks might have some marginal impact on supply. It cannot influence the effect on oil price movements caused by US monetary policy. This is key since it was the tightening of US monetary policy in the summer of 2014 with the ending of QE, leading eventually to the rise in interest rates in December 2015, which was the single biggest factor causing oil prices to fall.
Why then, if the effect of an oil production freeze on oil prices can only be minimal, are the Russians and the Saudis even talking about one?
The answer has been provided by Omar Al-Ubaydli, who is a programme director at the Bahrain Center for Strategic, International and Energy Studies as well as an affiliated senior research fellow at the Mercatus Center at George Mason University
“In the case of Saudi Arabia and Russia, both countries are seeking closer relations, and they want to project a good relationship to the rest of the world. They both know that there’s no chance of effective cooperation in oil markets due to market forces, but there’s no harm in having an extra meeting, and issuing mutually supportive statements.”
In other words, at a time when Russia and Saudi Arabia are intent on improving their relations with each other, it is in their joint interests to appear to be cooperating on oil production and prices, even if in reality that cooperation does not amount to very much.
By at least going through the motions of talking to and agreeing with each other, they send out a strong signal – first and foremost to the US and Iran – that despite their differences over the conflict in Syria they remain friends.