Syed Rashid Husain

 The writer is Vice President of Al-Khobar-based Al-Azzaz Est., eminent journalist and energy analyst. He writes a popular weekly column   ‘Energy Outlook’ for Saudi Gazette and also contributes to Pakistan’s Dawn and the BBC.

A New Geopolitical Reality

by shariff mohammed | Mar 02, 2017

The New Year begins on a positive note. A new realignment is taking shape in the regional context and oil and energy are playing a defining role in this emerging reality. Despite awful history, Riyadh and Moscow have agreed to a crude output cut and it appears sticking too. Months of back door energy diplomacy, at the highest level, helped overcoming the lack of trust between two energy powers.

Moscow has been known of failing to keep its output cut commitments with OPEC - several times in past. A Platts report highlights Russia reneging on its commitments with OPEC in March 1998, March 1999, November 2001, December 2001 and as recently as November 2014.

Even now, there are some insisting that it may not be too different from past. With the Russian Ministry of Energy continuing to maintain the same forecast on production growth, with total output in 2017 to reach 548 – 551 million tons (11.01 -11.07 million barrels per day), questions persist about Russian intentions. Some also suggest the Russian offer to reduce supply by 300,000 bpd basically portrays natural declines from its older fields.

Things but appear different - this time. The Russian government, including President Putin himself, have made a substantial reputational commitment to making the deal work. As per press reports, the agreement follows almost a year of petro-diplomacy that led Russian president Vladimir Putin and Deputy Crown Prince Mohammed Bin Salman. In order to reach a deal on the issue, they agreed to put aside their differences over Syria and other ongoing regional wars. The deal involved direct talks between the top leadership of the two countries, while the breakthrough reportedly came from a late night phone call between the Russian and Saudi oil ministers. “Negotiations from technical to leadership went on for a year with meetings in Russia and elsewhere,” one OPEC delegate was quoted as saying.

The involvement of Putin, adds weight to Moscow’s commitment. Ronald Smith, Citigroup’s senior Russian oil and gas analyst, is of the view that, the maths of higher prices versus lower production also adds to the impetus to the Russian government to follow up on the commitments. This is based on the fact that oil taxation has traditionally provided almost half of the country’s tax revenue and because the Russian oil tax regime is highly geared to the price of oil.

For example, extraction taxes and export duties combined go up $8.30 per barrel for every $10 rise in oil prices. The net effect of a 300,000 b/d output cut and a $10 oil price increase would be a 28 per cent increase in oil tax revenues in US dollar terms, and 15 per cent in local currency terms, giving a material boost to the Russian government’s efforts to balance its budget.

As for Russia’s ability to cut output and questions about the Kremlin’s legal authority to dictate production levels, while the government may lack formal control over output, it has substantial informal influence over the industry, Citigroup’s analyst believes.

And then answering the question, why would Russian independent producers voluntarily reduce output, Smith thinks most Russian oil companies have at least some older fields that are at best marginally profitable, with economic rents predominantly going to the government as taxation. One large Russian oil company estimated last March that “over 30 per cent” of its producing fields were uneconomic. While this could partly be due to the low oil prices at the time, it also lends credence to the suspicion that there may be a material amount of Russian production that remains on-line to generate tax revenues for the government than profit for the producing company, the analysis added. 

In order to comply with the agreed upon output cuts, Moscow convened a meeting of 12 oil producers that account for around 90 percent of Russian output. After the meeting, the Russian Energy Minister Alexander Novak told reporters: "We agreed that the reduction will be in proportion to the production volumes (of each company)."

Novak though reiterated that the cuts will be voluntary for each company and that there would be "separate discussions" on production-sharing agreements involving a number of foreign energy companies, including Exxon Mobil.

Saudi Arabia and Russia today together account for more than a fifth of global oil supplies. The first global crude supply pact in 15 yearsis underlining the growing energy amity between Saudi Arabia and Russia, “It is very significant to have an agreement by the two powerhouses that are Russia and Saudi Arabia,” said Olivier Jakob, an analyst at the Petromatrix consultancy.

A new geopolitical dynamics is being created and it has the potential to transform the global oil markets. 

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