The Bearish Threat Within OPEC

Authored by Cyril Widdershoven via OilPrice.com,

After a prolonged oil price plunge, pushing price levels down to around $59 Brent per barrel, signs are showing that the market believes the downward trend has overshot its target.

Concerns about global demand and supply have been wreaking havoc, based on assessments that the ongoing China-US trade war will put a major dent in demand. At the same time, U.S.-based oil storage volume reports showed a significant increase, killing off the bullish case for oil.

Despite this, OPEC+ refused to react, simply stating that the oil cartel and its Russian supporter were not willing to take appropriate measures to quell the confidence crisis in the market. Up until now, OPEC+ has seemed to be willing to take the wrath of Washington and others for keeping to its existing production cut agreement. There are even signs that the oil producers are considering a rollover of the production cut agreement at their upcoming meeting, presumably in June but most probably in July. A strong pro-roll-over front has been building up, led by Saudi Arabia’s Minister of Energy Khalid Al Falih, UAE’s Minister Al Mazrouei, and, surprisingly, Iraq. The leading Arab oil producers are taking the long-term view that the market has not yet stabilized, crude storage volumes are still too high, and demand is yet to see a tangible drop. There are signs, however, that a conflict is brewing within the oil group – with Russian officials spreading uncertainty.

In stark contrast to the full-scale support of a production cut that was given by Russia at the St Petersburg meeting in 2018 to OPEC, Russian president Vladimir Putin is now increasing the pressure on the agreement. By stating that Russia is happy with current price levels of around $60-65 per barrel, he has broken from the Saudi-UAE angle. Putin’s remarks threaten to push OPEC into a position where it will have to address possible shortages in the market in the coming months. By referring to a lower price level in public, Putin has acknowledged that Moscow is not interested in targeting higher prices, unlike Arab producers that need higher prices to support their own government budgets and diversification packages. Putin’s comments could even be interpreted as a willingness to leave the current production cut agreement, further undermining OPEC’s strategy.

The main question for oil analysts at present is whether Putin really stands behind his assessments. By reiterating that Russia is happy with lower prices and suggesting that the Russian government budget is based on $40 per barrel Putin is taking a risk. When analyzing the current state of the Russian economy, its global power projections and the extremely high costs of its ongoing military operations in Syria and elsewhere, higher oil and gas revenues would be a godsend. Putin’s dream of a Pax Russia cannot be built on $40 per barrel, not even on $60-65 per barrel. The Russian chess grandmaster seems to be playing on two boards at the same time. Putin’s attitude towards OPEC has always been one of ambiguity, taking the position that the oil cartel’s influence should be used to enhance Moscow’s geopolitical and economic influence. By creating a new front, some say against the USA and the EU, Moscow and OPEC have set up a marriage of convenience, built on a traditional commercial-strategic basis. OPEC+ is still very functional, but if Russian oil and gas oligarchs, the main support base of Putin at home, start to complain, the Russian tsar will need to act. It seems that the signs of political infighting have now become clear, with Russia’s minister of Energy Novak, formerly a supporter of the production cut agreement, keeping silent. In staying out of the discussion, Novak is lending credence to the idea that Russian oil companies may be running out of patience.

Strategically, lower oil prices would not only increase Russia’s market share, at the expense of former allies Venezuela and Iran, but would also help to constrain US shale. Saudi Arabia’s position on production is entirely different. Faced by high expenditure patterns due to the Kingdom’s economic diversification plans and regional military engagements, Riyadh needs a higher oil price. Change is being brought to the country slowly and with minimum risk to the regime. Higher oil prices will be vital if Saudi is to stand a chance of successfully implementing its visions.

Russia will be of particular importance in the coming weeks. Putin is facing the end of his political reign in the coming years, and growing dissent within the oil and gas sector is now noticeable. The Russian leader, maybe still hoping for a new political career, needs the support of Rosneft, Gazprom and others in order to survive and keep his legacy in place. Taking all of this into account makes the odds of Russia taking a bearish stance on oil all the more probable. It is likely that a roll-over of the agreement will not be issued, with heated discussions already happening between the main parties.  It seems that it is not Trump who will influence oil markets in the near term, but rather two Arab Crown Princes and a Tsar heading for retirement.