OPEC minus: Sanctions push Russia into competition with Saudi Arabia as price war looms

RU

OPEC+, a group of oil-producing countries that added major producers like Russia and Mexico to the original hydrocarbons cartel, emerged in response to the decline in global prices — from $114 per barrel in 2014 to $27 in 2016. At that time, oil prices were falling due to increased production from U.S. shale fields and a slowdown in China's economy. The group’s years-long, coordinated reduction in production paid off, keeping prices above a critical level below which production would decline — $27-28 for Russia, but $45-55 for most OPEC members.

“Many producers of more expensive oil started investing money,” commented Pavel Sorokin, then an analyst at the Ministry of Energy and now Russia’s Deputy Minister of Energy. “Starting from 2017, we saw an inflow of investments in shale projects — activity began in Canada, Brazil, and the Gulf of Mexico,” he said of the market’s response.

Pandemic: Russia loses the first price war

Despite its initial success in stabilizing prices, serious discord arose among OPEC+ members in 2020 amid the COVID-19 pandemic. Logistics chains worldwide ground to a halt, and fuel demand sharply decreased. Events developed rapidly, both in offices and on the stock exchange. At the March 6 OPEC summit in Vienna, members agreed to cut oil production by 15 million barrels per day during the second quarter of the year. Russia advocated for milder restrictions, rejecting OPEC's request and effectively breaking the existing partnership.

Just a few days later, Saudi Arabia announced a significant reduction in official prices for its buyers in Europe and Asia, demonstrating Riyad’s full readiness for an aggressive battle with Russia for customers. This announcement caused a price collapse: the benchmark Brent crude price fell by 30% in one day — the largest drop since the Gulf War. On March 10, the kingdom announced a sharp increase in production — by more than 2.5 million barrels per day.

As a result, by the end of March 2020, prices hit a 20-year low, and on April 1, the cost of Russian Urals crude oil approached $10 per barrel, approximately equal to the production cost of oil at light and conventional Russian oil fields. The situation pushed Moscow to seek a compromise. That April, OPEC+ countries signed another agreement to cut production, this time by almost 10 million barrels per day.

Cold peace and benefits for all

The 2020 OPEC+ agreement remains in effect today, albeit in revised form. According to the deal, Russia must reduce its oil production by 471,000 barrels per day — to less than 9 million barrels per day by the second quarter of 2024 — bringing it into alignment with the production level maintained by Saudi Arabia.

“We agreed with our colleagues that these voluntary cuts can be adjusted if necessary…towards increasing supply. This is an ongoing process,” says Russia's Acting Deputy Prime Minister Alexander Novak.

The agreements with OPEC+ are politically crucial for Russia. By securing the support of the wider oil-producing group, Russia gains added protection against strict Western sanctions on the purchase of its oil and petroleum products. So long as the other countries adhere to the limitations placed on their own production, Russian barrels cannot be removed from the global market without risking price shocks and inflation. This fact makes it more difficult for the U.S. and its partners to take even more drastic actions aimed at limiting Russian energy sales.

Saudi Arabia, as the world’s other swing oil producer, has effectively been assisting Russia by balancing volumes in order to maintain oil prices within the desired range. Doing so is in the kingdom’s self-interest. According to the IMF, Saudi Arabia needs an average oil price of $96 per barrel with a daily production of 9.3 million barrels to balance its budget. On the other hand, the Russian government has set the indicative Brent crude price at $85 per barrel, while Russian oil is priced lower at $71.3 per barrel.

External and internal competition

Due to consistently high oil prices in recent years, several countries have sharply increased production at new fields. Among these are Guyana, Brazil, the U.S., Canada, Iran, and Venezuela. According to the U.S. Department of Energy, the growth in production in the first four countries alone will drive global oil supplies up by 0.4 million barrels per day in 2024 and by 2 million barrels per day in 2025. Here, OPEC+ has made attempts to act proactively, bringing Brazil into the cartel on January 1, 2024 (albeit without a quota on production).

The second enemy OPEC faces is energy transition — the gradual shift away from fossil fuels toward cleaner and renewable energy sources. Not long ago, the global community was seriously discussing the prospect of developed countries achieving carbon neutrality by 2050–2060 while reducing or stopping investments in oil field development. However, against the backdrop of soaring commodity prices in global markets, these transition timelines are gradually being pushed back. Moreover, the growth in investments in oil and gas projects provides reassurance to producing countries. In the words of the Russian Ministry of Energy, “according to all forecasts and common sense” oil demand will continue to grow for at least a decade.

In what seems like a favorable situation of high prices and stable demand, one might expect suppliers to thrive peacefully. However, with European buyers closed off from Russia, exporters are now vying for a larger share of the Asian market. The main buyers of Saudi oil, which represents about 17% of the global market, include China, Japan, Korea, India, and countries of the ASEAN group. Russia is making significant inroads into this territory. In 2023, for the first time since 2018, it became the largest oil supplier to China, selling 107.2 million tons while the OPEC leader supplied 86 million. A similar trend is observed in India: according to Vortexa, in 2023 Russia accounted for 35% of the country’s oil imports, Iraq for 20%, and Saudi Arabia for less than 15%.

{{quote_srBblXvA!}}

However, heightened scrutiny over compliance with U.S. restrictions on Russian oil trade and transportation — coupled with the threat of secondary sanctions — have compelled many Asian refiners to reassess their stance toward Russian oil. Indian refiners, for instance, have become more discerning in their purchases and have explored potential reductions in Russian imports. Meanwhile, several Chinese banks have tightened oversight over payments involving Russian entities, apprehensive of potential repercussions from the West. While this situation has enabled Saudi Arabia to claw back an extra 1% of the market, Riyadh has thus far opted to adhere to a strategy of reducing volume while increasing price.

On the verge of conflict

In the event of a renewed competition akin the one that occurred in 2020, what options would Saudi Arabia have? According to the International Energy Agency (IEA), the kingdom possesses the capacity to swiftly ramp up production by more than 3 million barrels per day, which it could do in order to secure maximum market share. Concurrently, OPEC's collective spare capacity exceeds 5 million barrels per day, representing approximately 5% of global oil production. In contrast, Russia lacks such extensive capabilities to increase production, retaining the potential to boost daily supply by only around 500-700 barrels per day. A sudden surge in oil supply would inevitably lead to price declines, though predicting the extent of this decline proves challenging, as it would be contingent upon the specific market dynamics at play.

Engaging in a price war is unprofitable for both countries, as each maintains its own price “floor” not far from the budgeted oil price. In 2024, Saudi Arabia's floor is $96 per barrel, while Russia's price is more comfortable: at $71.3 per barrel (for Urals, equivalent to $91.3 per barrel Brent) Russia's budget is balanced. The base price enabling the replenishment of the National Wealth Fund in Russia is $60 per barrel Urals ($80 per barrel Brent). But despite this seeming disadvantage, Saudi Arabia may still be better equipped to endure another price war thanks to its prospects for securing cheap loans from the U.S. Russia, which has made itself an international pariah for the sake of pursuing its unprovoked invasion of Ukraine, lacks such a safety cushion.

Is fierce competition between Russia and Saudi Arabia beneficial in the current landscape, where developed countries are striving to accelerate the pace of the energy transition and new conflicts are flaring up worldwide, leaving investors on edge? Hardly. Furthermore, stable prices are also in the interest of the U.S., particularly with extremely tense presidential elections looming in November. Over the past year, American companies have significantly ramped up raw material production, aiming to offset the effects of cuts within OPEC+. However, in the event of heightened competition, a price war may erupt — even if it is likely to prove unprofitable for all participants.

Two strategies

When it comes to the long-term competition between Russia and Saudi Arabia in Asia, here too the kingdom holds greater financial maneuverability, boasting a Sovereign Fund exceeding $900 billion. Riyadh aims not only to solidify its position as an oil supplier in Asia, but also to emerge as a co-investor in advanced energy transition technologies. Through such strategic investments, the country seeks to secure its ability to sell raw materials for years to come.

The impending conclusion of the historic defense pact between the kingdom and the U.S. holds the promise of providing Saudi Arabia with security guarantees, granting it access to advanced weaponry previously unavailable, and potentially initiating the first steps toward improving diplomatic relations with Israel. Moreover, the potential deal’s ripple effects may extend to OPEC+, bolstering the U.S. position in the region while concurrently undermining that of Iran and China.

The state-owned company Aramco aims to convert 4 million barrels per day into petrochemical products by 2035 (about 40% of total oil production), meaning its investments are mainly directed towards the plants necessary to do this. Aramco is currently in negotiations to acquire a 10% stake in China's Hengli Petrochemical, one of China's leading companies in the sphere. Additionally, last year Aramco acquired 10% of China's Rongsheng Petrochemical, agreeing on a 20-year oil supply deal. The Saudi state giant also signed a joint venture agreement with two other Chinese companies to build a 300,000-barrel-per-day refinery and petrochemical complex.

The policies pursued by Saudi Arabia's state companies in India, the region's second-largest economy, are similar, albeit still on a smaller scale. A significant move was made in 2018 when the Abu Dhabi National Oil Company (ADNOC) and Aramco collaborated to join a consortium aimed at constructing a massive refinery in India with a capacity of 1.2 million barrels per day.

Russia, especially in the context of its war in Ukraine and the Western sanctions resulting from it, has far fewer opportunities to invest in new markets. The only news in this direction was Vladimir Putin's announcement that Rosneft plans to “build a plant” in India, but no details of the project have been disclosed by any of the participants. Since 2017, Rosneft has owned a stake of just over 49% in the assets of India's Nayara Energy Limited, which includes a refinery in the city of Vadinar.

Today, Russia's partnership with OPEC+ represents situational cooperation, subject to discontinuation if the parties no longer perceive benefits in maintaining production and stabilizing oil prices. Should scenarios arise in which fierce competition becomes more appealing than the status quo, Russia and OPEC may again quickly transition from allies into rivals pursuing market share.

How influential is OPEC+ really?

The impact of collective oil production cuts on prices may not be as significant as commonly believed, according to analysts at the European Central Bank, who suggest that during the pandemic, the effect of OPEC+ was “quite limited.” Their calculations indicate that, on average, without OPEC+ cuts, the oil price would have been only 6% — i.e. $4 per barrel — lower. Achieving the ambitious goal set by the coalition would require much deeper production cuts and significantly stronger cohesion, the authors conclude.

Similarly, IMF researchers assert that sharp oil price fluctuations stem solely from unexpected market decisions — it is the element of surprise that triggers substantial corrections, not the lack of coordination on the part of major producers. However, scientists from the U.S. Federal Reserve Board emphasize that overall, the existence of OPEC and its production regulation measures exert a stabilizing effect on prices, curbing price volatility.