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OPEC Needs This One Country to Boost Oil Prices – and They’re About to Cave In

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On September 26-28, the biannual meeting of the International Energy Forum (IEF) will take place in Algiers. Ministers, officials, and CEOs from the IEF’s 72 members (including both OPEC countries and the European Union and United States) will be in attendance, with several panel discussion scheduled.

opec meetingBut the most interesting meetings will be the informal “side-bar” conversations between OPEC and other oil producers.

Once again, they’ll be talking about “production stability” – in other words, a production cap to help support globaloil prices.

Now, whenever meetings between OPEC members and other oil producers are mentioned, the conversation always shifts to one particular country – and for good reason.

Without them, no production cap deal is possible.

And this country now has a very good – and very urgent – reason to support a push for higher oil prices.

Here’s what I mean…

This Is Saudi Arabia’s Main Non-OPEC Partner

I’m talking, of course, about Russia – the largest producer outside OPEC that hasdirect governmental administrative control over its oil production.

Depending on how one totals up extraction rates, the United States is probably the largest non-OPEC oil producer. But American production is decentralized – unlike in OPEC countries or in Russia, there is no national U.S. oil company, nor any pervasive government control over field operations.

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So while there will be a U.S. national delegation at the IEF in Algiers, it will only be marginally involved in the production cap discussions. There is simply no direct way for the U.S. government’s policy on oil prices to translate to actions of private companies with the real control over national oil production.

That leaves Russia as the primary non-OPEC player in the oil price drama…

Unlike the United States, Russia Has Central Control Over Production

There, the Kremlin certainly does determine national production. The two main venues through which the government channels its energy policy are Rosneft (oil) and Gazprom (natural gas).

While both companies have sold shares to private investors, the state retains a majority hold over them.

In the build-up to Algiers, Russia has indicated that it is willing to discuss a production freeze. Even just the anticipation of a joint Russian-Saudi statement during the G20 summit that took place in China over the weekend resulted in a brief spike in oil prices on Monday.

However, once the actual statement appeared on Tuesday, it was more of what the market has been hearing for months – and oil prices started the morning by heading down as a result.

Now, this might sound familiar, and for good reason.

All of this parallels a similar attempt to agree to an oil production cap during the Doha meetings back in April. That initiative failed – and so will Algiers.

No breakthrough on a production cap is likely at the IEF, although I expect the groundwork to be laid for a more substantive move later this year. Now, I’ll be talking more about what will be going on in Algiers as we move closer to the opening of the three-day event on September 26.

But today, it’s important to note one key reason why a deal is likely before the end of the year.

Russia now needs an oil cap to be in place – badly…

Russia Depends on Oil and Gas Revenue – and Both Fall Along with Oil Prices

Of course, Moscow has been feeling the negative effects of low oil prices for some time now.

The country’s central budget depends on export revenue from the sale of oil and natural gas. To make matters worse, the price of gas, especially for Russia, is also integrally tied to the price of oil. Gazprom, Russia’s gas-export giant, prices its gas based on a basket of crude oil and oil products.

So a low oil price translates into a double-whammy for the Kremlin: lower oil revenue, as well as lower gas export revenue.

This low price environment has pummeled the ruble; the currency remains more than 65% below its exchange value at the time oil prices began to slide in late 2014.

That has translated into across-the-board problems in Russia’s domestic economy, accelerating inflation, and the inability of most citizens to import a range of products, including essential medicines. Prices have risen far beyond payouts from pensions and social programs, making those living on fixed incomes particularly vulnerable.

The crisis has been made even worse by the Kremlin’s tendency to run certain strategic programs off-budget.

With oil at $80 a barrel or more, it was easy enough for the government to cream off a portion of oil revenue to fund projects that didn’t appear in the budget directly, while still funding the “visible” budget items.

But things have changed…

Russia’s Budget Cannot Deal with Today’s Oil Prices

With Brent (the benchmark oil price set daily in London) trading at less than $50 a barrel and Russia’s export-grade crude oil fetching a market price some 15% below that, matters have become acute.

Moscow’s budget was initially designed with an $85 Brent-price in mind. At about half that, today’s oil prices don’t allow the Kremlin to use declining export revenue to fund both the official budget and off-budget projects.

Drastic program cuts and rising taxes have been the result.

It was against this backdrop that Russia came out in support of a cap at Doha back in April. The proposal under consideration then would have capped global production at January rates, which were the highest in years and already stretched national capabilities worldwide.

The reason for that was simple: It’s always easier to adopt a production ceiling that most countries cannot reach, let alone break, even if they wanted.

Despite support for a cap from Russia and most OPEC members, the initiative failed when Saudi Arabia demanded that Iran (which wasn’t even at the meeting) agree to a cut as well. Discussions promptly collapsed.

Russia’s Energy Ministry was livid over this development, claiming that Russian participation in discussions had merely been used as a decoy in Saudi Arabia’s long-running geopolitical tussle with Iran.

Moscow’s response was to promptly turn on the taps full force. OPEC responded in kind, and an even greater volume surplus resulted in the international market. The budgetary pain both in Russia and OPEC continued.

But this time around, there is another factor dictating a supply freeze – one that affects both Saudi Arabia and Russia in a similar way…

Russia Also Needs Higher Oil Prices for Its Own Upcoming Stock Sale

Both countries now have a vested interest in improving the value of reserves in the ground.

Saudi Arabia will be selling 5% of Aramco, the national oil giant and the world’s largest oil company, and expects to receive some $2 trillion from the IPO.

But the value of Aramco, and so the exact size of that $2 trillion payout, is determined by the value of the company’s oil reserves.

That in turn is set by the price of oil. So to reach the IPO payout they want, the Saudis know they will have to raise oil prices.

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Russia is in a similar situation.

Moscow is currently planning to sell additional shares in Rosneft on both domestic and foreign exchanges.

Last time this happened, the listing happened on the London Stock Exchange (LSE). This time, that’s less likely given the UK’s support of Western sanctions against Russia for its moves in Ukraine.

Nonetheless, Moscow has been forced to reduce the expected take from the stock sale significantly in the face of continuing low oil prices. What was originally expected to bring in a much-needed $18.5 billion has now been reduced to about $11.5 billion.

Either way, the Kremlin will continue to control this mega oil company, but the privatization remains essential to patching holes in state budgets for several years to come.

To get as much as they need, the Russian government must now raise the price of oil.

That puts both Russia and Saudi Arabia in the same boat on oil prices, for the same reason.

And that means the outlook for an accord on oil prices going forward is good.

 

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The post OPEC Needs This One Country to Boost Oil Prices – and They’re About to Cave In appeared first on Money Morning – We Make Investing Profitable.

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