June 18, 2019 01:22 PM RSS

Mutually Assured Economic Destruction Forces Saudi Arabia and Russia to Negotiate Reduction in Oil Production

Mutually Assured Economic Destruction Forces Saudi Arabia and Russia to Negotiate Reduction in Oil Production

Recently I have written in Wall Street Rebel... “it's not a matter if Saudi Arabia and Russia will come to a serious binding agreement to reduce their countries' oil exports ... it's a matter of when and they will be forced to do it, out of economic necessity”.

Both oil exporters are in fact becoming more and more motivated as each day passes by growing domestic economic and political pressures. In the last two weeks, the two lowest cost producers of oil in the world have taken three key steps towards negotiating a serious cut in their oil exports in order to help raise the net price they're getting for crude on the world market.

The first step taken towards an eventual coordinated reduction in oil exports began this past December. Several reliable news reports surfaced indicating the House of Saud was finally seriously considering making a large military and aviation equipment purchase from Russia. According to "Kommersant-Money" a Russian news magazine, Saudi Arabia is on the verge of spending as much as US$10 billion initially on military hardware including several types of air defense.

The second step towards an oil export agreement also occurred last week with the negotiation of what the media is calling a "cease fire" in Syria. While the media has exaggerated the agreement, it is true that Secretary Kerry, Russian Foreign Minister Sergey Lavrov, and a group of 17 other countries have taken a big step towards a cease fire. Instead, what they agreed to was an "initial cessation of hostilities" that will go into effect next week.

Even the watered down reality of the agreement is still a promising first step that is designed to allow the immediate delivery of humanitarian aid to seven priority areas within Syria.

If the agreement holds and Russia shifts its current airstrikes in Syria towards hitting the Islamic State which controls territory in Syria's east, Jabhat al-Nusra, and Al-Qaida's Syrian affiliate targets, instead of focusing on the U.S. and Western backed anti Assad regime rebels, we could see Saudi King Salman actually get on his Royal Jet and go to Russia to discuss and finalize the first of many multi-billion dollar military arms purchases.

Of course, the Russians will insist that Saudi Arabia refrain from sending military troops into Syria, as it has threatened, for the thaw in relations between these two countries to become a reality. But if the Saudis stay out of Syria, and the Russians live up to the shift in its targeting, the chances of the two power brokers in the Middle-East securing a cease fire are very strong. Albeit with the usual starts and stops that are so often the case with these types of deals.

The third step towards an oil export agreement was the unexpected agreement between Russia and Saudi Arabia this past Tuesday to a conditional oil export freeze. Both agreed as a first step not to exceed their January 2016 oil exports levels.

While this agreed freeze is contingent on other non OPEC producers joining in the agreement, the sole oil exporter likely not to agree will be Iran without some concessions. Both Russia and Saudi Arabia appear willing to make the needed concessions to get the Persian theocracy's agreement to both the freeze and eventually to secure an export ceiling.

When considering Iran's current export capability after years of international sanctions, you have to keep in mind the current depressed market price of oil and the poor condition of its oil production infrastructure, it's unlikely that Iran will be able to export the one million barrels a day it has set as its target. Iran desperately needs investment in its oil industry to revitalize its crude oil production capability. The kind of investment needed to revitalize Iran's oil industry just isn’t going to come if oil continues to trade between US$25 - $35 a barrel.

The sudden attempt made by Russia and Saudi Arabia’s first freeze oil export was announced by Saudi, Russian, Qatari, and Venezuelan oil ministers who attended a hastily organized and previously unannounced meeting in Doha, Qatar.

With Russia and Saudi Arabia having so much at stake, this could be the first joint OPEC/non-OPEC oil deal that gets made in 15 years. No matter how you look at this, it's the first sign that the largest and smallest state oil producers are willing ratchet down their exports on a shared basis by as much as 1.5 million barrels a day.

Reducing the amount of oil being sold into the world market by that much a day would quickly eliminate the oversupply and potentially drive oil back over US$40 in just a few weeks. If an agreement by OPEC and Non OPEC oil producers can be negotiated and actually holds - it's entirely likely oil would rise back over US$50 a barrel by the end of the year.

Keep in mind, by the end of this year, oil production in the United States will drop by an estimated 600,000 barrels a day. The flooding of the oil market with supply the past 18+ months has literally crippled shale and standard oil production in North America. The active rig count in the United States has fallen by more than 1,000 in the last 12 months. A rise back to US$40 a barrel even US$50 isn't likely to spark a resurgence in either oil production or investment in oil production.

Bankers and investors have been scalded by the price decline in oil and will be very wary of recommitting to oil investment opportunities until oil stays above US$60 a barrel for an extended period of time.

Ironically, Saudi Arabia's oil glut strategy designed to derail Russia's ability to support Iran and the Assad regime has turned into a strategy of mutual assured economic destruction. While the Russian economy has been hammered by low oil prices and compounded by international sanctions over Crimea and Ukraine, the Saudi economy has also been so impacted that it's been forced to make cuts in its cradle to economic privileges it provides its citizens. Cutting these economic benefits risks whipping up political, social, and religious dissidence.

So the Saudis and Russians have a lot at stake in agreeing to oil export reductions while the economic and political pain of US$25-$35 crude has also been wreaking havoc on Brazil, Ecuador, Mexico, Canada, Libya, Niger etc., creating an environment that should make a comprehensive agreement to reducing oil exports genuinely possible.

Venezuelan Oil Minister Eulogio Del Pino is under great pressure by the Maduro government to get a comprehensive deal among state exporters quickly after Tuesday’s announcement and agreed to join several OPEC oil ministers in a meeting that started on Wednesday in Tehran with Iran and Iraq oil ministers.

While Iran is Saudi Arabia's arch nemesis, sources close to OPEC discussions have told news services like Reuters that Iran will likely be offered special terms as part of the output freeze deal to bring them into the Russian/Saudi sponsored agreement.

"Iran is returning to the market and needs to be given a special chance, but it also needs to make some calculations," said one source. Saudi Oil Minister Ali al-Naimi confirmed that the freeze is just the beginning of a negotiation saying ..."The reason we agreed to a potential freeze of production is simple: it is the beginning of a process which we will assess in the next few months and decide if we need other steps to stabilize and improve the market."
"We don't want significant gyrations in prices, we don't want reduction in supply, we want to meet demand, we want a stable oil price. We have to take a step at a time."

Keep in mind Russian Deputy Prime Minister Arkady Dvorkovich said freezing oil exports was not a problem for his country as he expected its production to be flat this year versus 2015 anyway. A drop in exports of 600,000 barrels a day that yielded an additional US$10 even US$15 per barrel for oil exporters - is likely the formula needed for cooperation and to prevent cheating.

The economic reality is with oil at such low levels, a reduction in oil sales by all state owned exporters of oil is likely to actually defy history and hold. Producers have a history of cheating on export limits. At US$25-$35 crude, cheating becomes sheer economic cannibalism. Selling oil for less than it costs to produce is a potentially disastrous policy. A glimmer of economic sanity and hope for those investors and speculators for looking oil to climb higher! Read more at http:www.wallstreetrebel.com

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