Russia's pact with Opec designed to tackle oil woes is strengthening

An oil alliance between Saudi Arabia and Russia was once deemed unthinkable. Now a prolonged partnership looms in the face of their shared adversary — the oversupply created by the rise of the US shale industry.

The two oil superpowers, which pump one in every five barrels of crude, demonstrated in Vienna this week that their joint management of the market will remain a fixture of the industry long after an extended deal to curb supplies expires in March 2018.

Comments from Khalid al Falih, Saudi Arabia’s powerful energy minister and his Russian counterpart Alexander Novak, at a meeting of Opec and other big producers, imply that what was once a short-term pact designed to tackle an oil crash is strengthening.

Mr Falih made clear there was no intention to “abandon” their plan to try and balance supplies and “disengage”, just as cuts have put a floor under prices but still hover near $50 a barrel — half 2014 levels. Mr Novak hailed “a new era of co-operation”.

Together the countries spearheaded the plan to keep supply cuts equal to roughly 2 per cent of global demand split between 24 Opec and non-Opec countries, believing it will shrink swollen oil inventories that built up during the downturn.

The decision this week cemented the end of Opec’s previous strategy of trying to crush rival higher-cost producers — chief among them US shale — by opening the taps in November 2014.

“Saudi Arabia and Russia are essentially now co-pilots of this operation and they’ve made it clear there will be no going back to chasing market share,” says Helima Croft of RBC Capital Markets.

Ministers from both countries this week travelled in the same car, held press conferences together and publicised visits to oilfields in each other’s countries in a show of their alliance.

“It’s a huge change from two years ago when Russia would not co-operate with Opec and even questioned its relevance in the age of shale,” adds Ms Croft.

The original deal last November to cut supplies by Opec and big non-Opec producers — together responsible for more than half of world oil supplies — was only supposed to be a temporary fix to accelerate the oil market’s recovery from its slump.

But since cuts came into effect in January the US shale industry has shown that it can thrive in a world of $50 a barrel oil, with companies shrinking costs and accelerating drilling. US companies are set to add as much as 1 per cent of global consumption next year — a huge amount in an industry that can be derailed by small swings in the supply-demand balance.

Jamie Webster, fellow at the Center on Global Energy Policy at Columbia University, says the Saudi-Russia alliance underlines a need to live with US shale. While the plan to squeeze the upstart industry in a market share war had failed, they were now trying to adapt to its growth.

“They’re not just going to say ‘well shale’s now the king’,” says Mr Webster, adding they still wanted Opec to be producer with the power to balance the market. “They’re just trying to figure out how to do that.”

“It’s definitely a signal that they have not given up,” he says.

Both countries have much at stake. Saudi Arabia is pushing through a radical transformation of its economy and the initial public offering of its state energy giant Saudi Aramco, using higher oil revenues today to pave the way — politically and financially — for reduced dependence on its main resource in the future.

Russia too seeks stability ahead of an important election next March.

Delegates from Gulf Opec countries emphasised that there is a changing vision of what victory for Saudi and its newfound ally looks like. They believe that if they can reach a point when US shale is still growing but global inventories of crude are falling they will have demonstrated they still have the power to manage the oil market. They recognise it’s a long-term commitment.

“After the nine month deal the cuts don’t just end,” says one Gulf Opec delegate. “This is ongoing.”

Nigeria’s oil minister Emmanuel Kachikwu acknowledges Opec had slightly diminished ambitions, however, saying they did not want prices to rise too far back above $60 a barrel as it may further boost US shale.

Some oil traders remain unconvinced that they will succeed in stabilising prices even above $50 a barrel and doubt Russia’s resolve for long term oil market management. They see Moscow as opportunistic; willing to reap the benefits of higher prices for now but also keen to keep expanding its own energy industry.

They also believe Opec and its allies are underestimating US shale growth. Compliance with the production cuts could weaken over time, and some traders think they would have been better off agreeing a deeper cut for a shorter duration.

Brent crude fell more than 5 per cent in the wake of the meeting, setting a low of $50.71 early on Friday, before stabilising.

But the biggest threat traders see is that by emphasising the nine month duration of the extension and ambiguity about what happens after that, it implies production could flood back when the deal ends.

This is to misread the intention, however, says another Gulf Opec delegate. Both Saudi Arabia and Russia have pledged to do “whatever it takes” to balance the market. Historically, the cartel has rarely executed a hard stop to cuts, rather letting compliance weaken once there was demand for their crude.

“It is not a quick fix,” the delegate says. “[The extension] goes to show there isn’t a move to revert to another policy.”

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