- A new deal is being viewed with big optimism in the West, but it is premature?
- The actual numbers that Russia will be reducing are not equivalent to what is outlined in the deal.
- Coronavirus continues to have a major impact on global economies and therefore on the oil industry.
Under the new Saudi- Russo oil deal, Saudi Arabia and Russia lead the record for oil cuts as part of the agreement committed by 23 countries to withhold 9.7 million barrels a day from markets. Western publications, including The New Yorker, ran articles this week with headlines such as “How the Russian-Saudi Oil War Went Awry—for Putin Most of All.”
According to Reuters, the oil production could be reduced by 20 million barrels per day, which is equivalent to about 20% of world oil supplies. Since announcement of the deal between Moscow and Riyadh, the price of oil began to rise sharply. Russian President Vladimir Putin confirmed the reduction deal. OPEC countries came to an agreement to reduce oil production for two years.
- From May to June 2020: production will be reduced by 10 million barrels per day
- From June to December 2020 by 8 million barrels per day.
- From January 2021 to April 2022-by 6 million barrels per day.
It is possible that Russia might change the trajectory of the deal this summer. Russia is not thrilled at the fact that Saudi Arabia is trying to oust Russia from the European market. EU member economies are taking a hard hit with the coronavirus pandemic. It is highly likely EU members will enter a hard recession this year and even hyperinflation after they feel the full effects this fall.
Therefore, Saudi Aramco started offering European nations a 90 delay on payments. The deferral is possible through Saudi banks funding. The purchase agreement will include a promissory note that allows you to pay for the product 90 days after receipt. Given the dire state of the EU, the offer is quite attractive. Additionally, the Saudis are offering a discount of $10 per barrel.
Earlier, at a meeting on the situation in global energy markets, Putin said that his country is discussing with Saudi Arabia the issue of reducing oil production. At the time, it was reported that they were talking about a decrease of 10 million barrels per day.
Russian crude was supposed to be delivered mid month to Europe, but the cost of per barrel, as of yesterday, fell below $17. This will mean Russian crude companies will have to absorb losses. The payment deferral offer by Saudis would force Russian oil to be sold even cheaper, in order to offset the competition or to offer deferral themselves to match the Saudis. Below $17 per barrel, Russian companies are completely deprived of profits, and the Russian budget loses most of its revenue.
Will the deal made to reduce oil production have the desired results (stabilization of the oil prices)?
Last year, according to the available data Russia produced 560 million tons of oil. One tonne contains 7.4 barrels of oil.
At best Russian production would have to be reduced by 1 million barrels per day. Overall, in the whole year, it would mean a reduction of 365 million barrels per calendar year. From a percentage standpoint it is not much at all. If you compare this cut to the agreed deal, it does not hurt the Russian budget at all or even have any long lasting effects.
The optimistic views of OPEC members and the US are that the demand will increase by summer. This is an overly confident projection. Coronavirus continues to have a large impact on global economies and in turn has a certain effect on the oil industry. This hope is, of course, conditional since the behavior of such diverse players as Russia, the KSA and the United States can hardly be predicted in advance and with great accuracy. The signing of the deal did positively impact the stock markets. Since the pandemic, the stock market has been showing historic lows and this deal helped strengthen confidence.
The Kremlin remains a wild card and it is hard to say if they will even honor the deal going forward. KSA is another dark horse with possible issues within their fractions. Do not discount Venezuela and how Russia and US are embroiled in a geopolitical struggle for control in that country.
As much as the deal was a historic breakthrough, the chances of the Kremlin sticking to the deal is 50/50. Only time will tell if there will be actual benefits and results. For now an appeasement has been reached, but for how long?