The conflict in Ukraine has triggered tectonic shifts in international relations and the global economy and will undoubtedly significantly affect energy markets for the years to come.
Skyrocketing oil prices have pushed the global economy to the verge of panic. If oil prices remain over $100 a barrel, the European economies will certainly find themselves in a deep recession. As a result, this could also trigger political and social disruptions that could eventually lead to a shift towards Russia while weakening the Western coalition against Moscow. Such a scenario would certainly be most welcomed in the Kremlin.
Heavy sanctions on Russia have theoretically opened the window of opportunity for Middle Eastern producers.
Devastating war and heavy sanctions on Russia, coupled with the determination of the EU countries to end their dependence on imports of Russian oil and gas, have theoretically opened the window of opportunity for Middle Eastern producers to increase their market share. However, while Western sanctions and the isolation of Russia may also affect the internal dynamic of the Organization of the Petroleum Exporting Countries (OPEC+) group, their cooperation remains in place. In 2016, ten non-OPEC nations, including Russia, joined OPEC to form OPEC+ to have more control on the global crude oil market. Moreover, in 2018, Saudi Arabia and Russia reached a deal to actively manage oil markets for potentially the next 20 years.
Jim Krane, an energy researcher at Houston-based Rice University’s Baker Institute, recalls that in similar situations in the past when oil prices would spike like this, OPEC would have taken action to stabilize the market. “If things were bad enough, we would see spare capacity released by Saudi Arabia and one or two other producers at a minimum, the Saudi oil minister would try to talk down’ the market with some reassuring language,” he told Inside Arabia. But that hasn’t happened this time.
Despite repeated calls from the Western officials to increase hydrocarbon supplies, Gulf OPEC producers led by Saudi Arabia and the UAE have refused to do so.
There are several reasons for their refusal. First, OPEC members have been rather cautious about increasing their supplies at the expense of their partners –– such as Russia –– as this may lead to internal frictions that may seriously undermine the internal discipline that has always reflected a measure of discord. Exploiting the crisis and problems that some of their members are facing could potentially lead to unwanted scenarios and cause internal turbulence.
Because Russia has been a major oil market partner of Saudi Arabia and OPEC, the latter must consider Russia’s preferences. In this regard, Krane noted that nobody wants to be blamed for “stealing” Russian market share –– a complicating factor that pushes the prices up.
According to Gal Luft, Director at the Center for World Political Economy and faculty member of Turkey-based Ostim Technical University, Saudi Arabia and the UAE’s refusal to ramp up production is rooted in economics rather than diplomatic concerns.
He explained that if the two countries increase production, and at the same time so does the US along with releasing oil from its strategic reserves while Russia’s oil effectively remains in the market, this convergence of actions could cause a glut in the market and a collapse in prices which would harm them economically. The Saudis and Emiratis are very concerned about this scenario and will not agree to take such a risk.
“Neither Saudi Arabia nor the United Arab Emirates are in any hurry to increase production.”
“Neither Saudi Arabia nor the United Arab Emirates are in any hurry to increase production at this stage because both countries, and most other OPEC states, took a big financial hit when the oil price collapsed in early 2020, and they are only recently benefiting from a price above that needed to balance their respective budgets,” said Chris Weafer, Chief Executive Officer and General Director of Macro-Advisory, to Inside Arabia. He thinks that all OPEC states would prefer to have a longer period of budget surpluses to rebuild their cash reserves and to improve their balance sheets. “For now, it is more about the money than about politics,” he added.
In a similar vein, Dr. Cyril Widdershoven, a long-time observer of the global energy market and owner of Dutch consultancy VEROCY and Global Head Strategy & Risk at Berry Commodities Fund, thinks that while there are plenty of reasons to break up this Russia-OPEC connection, the breakup would also bring a lot of volatility in the market which could result in a price decrease to below $60 per barrel, something that OPEC will try to avoid at any coast.
Moreover, unlike the Gulf OPEC countries whose currencies are pegged to the US dollar and are therefore unable to cut the budget oil price, Weafer noted that Russia has a flexible currency exchange rate, so it was able to adjust to the lower oil price and to western sanctions very quickly. He explained that in 2013, the year before the sanctions started and before the oil price fell (from $115 p/bbl in June 2014 to $25p/bbl in January 2016) Russia needed $115 per barrel to balance its budget. However, last year their prices were down to $50 per barrel.
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It is therefore in OPEC’s interest “to continue the collaboration with Russia and other non-OPEC exporters since this way OPEC can more easily resist the pressure by the West and its honorary members to ramp up production,” Krane noted. As for Widdershoven, he attests that “one should also keep in mind that no Arab Sovereign Wealth Funds have sold or divested its assets in Russia,” and therefore their cooperation remains relatively solid despite accumulated international challenges.
Yet, the geopolitical and diplomatic factors should not be underestimated as it is more than evident that relations between some of the Gulf countries (notably KSA and UAE) and the West (especially the US) have been very turbulent over the plethora of unsolved issues. So, one of the main reasons why the OPEC deal with Russia is still in place could be also attributed to tensions between the Biden administration and some of the Gulf countries, according to Widdershoven.
While the brutal killing of Washington Post columnist Jamal Khashoggi tops the list, the Saudi and UAE involvement in neighboring Yemen’s war has also been one of the key issues that have corroded the bilateral ties with the West. The personal relations soured even more after Biden threatened to turn Saudi Arabia into a “pariah” state due to its significant violations of human rights. Finally, Gulf oil producers have also been extremely unhappy with the US-EU position towards the JCPOA discussions with Iran, which only further complicate the situation and prolong their reluctance to bring spare capacity online. Several Arab producers, according to Widdershoven, are also using oil as a leverage to pressure the US and EU as a response to their support to Arab Spring.
OPEC’s unwillingness to increase oil supplies appears to be a political decision.
This is why from the US perspective, OPEC’s unwillingness to increase oil supplies appears to be a political decision, according to Krane. In his opinion, it is becoming obvious that neither the UAE nor Saudi Arabia has any appetite for helping the Biden administration with gasoline prices for the upcoming US election.
However, this may change in the long term, as some of the OPEC members, such as the UAE, have hinted that they would be prepared to raise production. It is believed that OPEC will gradually increase its presence in the European oil market, at a pace that avoids tense relations with Moscow. Indeed, at an online meeting, at beginning of May, OPEC+ agreed to gradually increase the flows by adding 432,000 barrels per day in June. However, one should bear in mind that the gradual opening of the oil taps is part of the OPEC strategy to regularly increase its production in order to make up for the cuts made in 2020 during the worst time of the pandemic-related recession. It has little to do with the war in Ukraine.
Yet it is evident that none of the big producers wants to risk the market oversupplying again. According to Weafer, producers will wait until there is more clarity about the demand trend in order to be better able to evaluate Russia’s supply position.
Nevertheless, Weafer thinks that OPEC+ may not survive in its present structure because of the impact of sanctions on Russia’s position as a major oil exporter. He believes “Russia may become less important for OPEC and there will be less of a need for such close cooperation, as seems to be the case since early 2020.” The ban on the import of Russian oil and oil products by the EU and the US is, according to him, “expected to lead to a permanent reduction in Russian oil production and export volumes of 2.0 to 3.0 million barrels per day (Europe and the U.S. have accounted for approximately 5.4 million barrels of Russian oil exports).” While Russian producers should be able to divert approximately half of their exports to Asian customers with discounted deals –– particularly in India and China –– Weafer indicates that they will not be able to divert all of it because of logistical difficulties.
There will be much less need for Saudi Arabia and the other major OPEC states to work with Russia.
As Russia becomes a smaller global market supplier and its supplies become tied to long-term discount deals with Asia customers, it will lose much influence in the global oil market. Weafer observes that there will be much less need for Saudi Arabia and the other major OPEC states to work with Russia or to include it in major production actions.
“I would not expect OPEC to formally cut ties with Russia when the current OPEC+ deal ends, but the need to agree on everything with Russia and accommodate Russia’s demands will be considerably less than it was before these sanctions,” Weafer noted.
Finally, Krane warns that by withholding production for political reasons, OPEC is demonstrating that its overriding concern is no longer stability of oil markets. Instead, “it’s all about bilateral relations with Russia and the United States, and this is a risky position,” Krane explains. Such an attitude may have long-term diplomatic consequences in a rapidly changing world order and it will probably speed up the inevitable shifts in the energy sector towards other solutions. Krane points out that “leaving prices above $100 per barrel will only hasten the adoption of those substitutes and every driver who switches to an EV is lost to OPEC forever.”
