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What OPEC’s New Romance with Russia Means for Oil Prices

This is a syndicated repost published with the permission of Money Morning - We Make Investing Profitable. To view original, click here. Opinions herein are not those of the Wall Street Examiner or Lee Adler. Reposting does not imply endorsement. The information presented is for educational or entertainment purposes and is not individual investment advice.

For years, the Organization of Petroleum Exporting Countries (OPEC) has courted Russia, though without much success. It’s easy to see why the attraction is there; the world’s largest country has huge oil reserves and the geopolitical clout to boost the cartel’s “muscle” by about a third.

But this past weekend, Russian Energy Minister Alexander Novak announced that Moscow is ready to meet with both OPEC and other oil producers to address the low price of oil.

This is an important development. It means that for the first time in nearly 11 months, geopolitics is likely to give support to higher crude – meaning oil prices get a new push.

We can expect something more from these meetings, as well…

Oil’s Plunge to $40 Has Everyone in a Tight Spot

OPEC’s decision to protect market share over price has even hit American producers, with their huge, expensive-to-extract new reserves of shale and tight oil.

But even as exporting countries struggle (sometimes violently) to balance budgets with deep oil revenue cuts, very little has been done on a geopolitical scale to correct oil prices. Major producers, like Russia, have appeared to sit back and watch their revenue crumble.

But now, Russia has all of a sudden cried “Дядя!” Uncle…

It’s who’s doing the producing that’s the pain point.

Whereas oil production in the United States is a private affair, in all other major producing countries, the sector is either led or controlled by state companies.

So for Russia and all OPEC countries, the dive in prices was more – much more – than a private sector bottom-line consideration. All government programs and expenditures are impacted.

To make matters worse, these economies are largely undiversified; oil is the sole source of revenue. Even in Russia, oil and natural gas are the primary sources.

But Russia also has other concerns.

The Western sanctions issuing from the crisis in Ukraine and Moscow’s annexation of Crimea have restricted access to the outside hard currency markets that are essential to actually exporting oil and gas – almost all contracts are denominated in U.S. dollars and must be pre-financed.

The “double whammy” of low prices and sanctions has resulted in a significant reduction in the value of the ruble. That, in turn, has created additional domestic market problems for average Russians.

But the pain isn’t limited to Russia. This “race to the bottom” is running every exporter ragged.

Someone Has to Blink… but No One Wants to Be First

All OPEC countries (with the exception of Iran, given its own sanction barriers and the dreadful state of its oil industry) have been producing well over their monthly quotas to their own detriment.

If that seems bizarre, it’s because they have no choice.

You see, the OPEC Secretariat determines these each month by first estimating global demand, then non-OPEC volume, followed by what is termed the “call on OPEC,” which is then divided into quotas for each cartel member.

Low prices have required that OPEC members flood the market with crude in an increasingly desperate drive to raise needed revenue. All that’s done, of course, is drive overall prices even lower.

As I said, that’s created downward pressure even for non-OPEC exporters, but Russia has the most acute problem. And Novak’s statement this weekend comes after indications from OPEC sources that an accord is developing.

Nobody yet knows exactly what this will mean or how any agreement will play out.

The consensus (which I happen to share) is that the Saudis require some kind of indication that the strategy to maintain market share has been successful.

In other words, somebody has to blink first.

If no one does, things could get ugly in some parts of the world, not just the markets.

We Could Be Faced with a “Latin Spring”

All OPEC members, even the Saudis, have faced an acute situation for some time, and all have been running increasing budget deficits. Riyadh has also begun to withdraw billions from foreign investments as the need to support domestic financial realities has intensified.

Other cartel countries are in more dire shape.

Venezuela, Nigeria, Libya, and Iran require oil prices in the high triple digits to have any pretense of stable central government accounts. Any price improvement notwithstanding, this is simply not going to happen.

Perhaps the most serious situation is taking place in Venezuela. The national economy has stopped functioning, there are food and commercial pricing riots in all major cities, and sources within the national oil company, Petróleos de Venezuela SA (PDVSA), privately acknowledge that reliance on crude revenue to import essential commodities has failed.

A transition of the crisis to the political realm would mark the beginning of a Latin American parallel to the Arab Spring.

With stability crumbling in Brazil and Argentina, economic problems intensifying in Ecuador (the smallest of the OPEC nations), and stabilization under pressure in Colombia, this could get very nasty very quickly.

We could be reaching a point where no one player or dramatic event can avert chaos or “re-bottle” the genie.

But investors might find that Russia’s new willingness to talk production cuts with OPEC provides a break in the weather.

Russia Could Help “Find the Floor”

Rising oil prices will not solve all of the problems, even if that rise were an accelerating one. But it would provide at least one welcome element.

Overproduction has become so bad that even Saudi Arabia has increased both productionand exports.

The convoluted rationale behind this tactic has strained credibility, but the real reason is simple: The Saudis cannot prevent other OPEC nations from raising volume in a desperate attempt to collect revenue. So they need to appear to be leading the effort.

Russia may be the short-term key to allowing OPEC to ease production levels – and allowing the Saudis to “keep up appearances.”

Moscow will never become a member of OPEC because Vladimir Putin’s Kremlin would never allow an outside organization to dictate how much oil it can produce or trade. But, unlike the United States, Canada, or Mexico, the Russians have had a high-profile observing delegation at the OPEC headquarters in Vienna for some time.

The stage now seems set for a Russian-Saudi meeting to precede a broader OPEC session. That should be enough for crude prices to find a floor and improve.

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The post What OPEC’s New Romance with Russia Means for Oil Prices appeared first on Money Morning. Reposted with permission.

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