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Putin Seeks Truce

08.02.2016

After eighteen years of price wars, Russia, the world's largest oil producer, had enough and lifts the white flag. Putin is ready to conclude an agreement with OPEC.

The Russian government has so far rejected all invitations from OPEC to join in a joint venture. However, the talks took a different turn last week. According to influential politicians, Russia and OPEC should join forces.

What has caused the turnaround? One important reason is that oil prices at current levels will force new draconian cuts in the state budget. Russia has assumed an oil price of 50 dollars per barrel for this year’s budget.

It is easy to imagine that new painful austerity measures in an economy that is already not functioning well can put the patience of Russians to the test, and trigger spontaneous demonstrations.

Another reason for the increased flexibility is the political calendar. Russia holds parliamentary elections this fall, and Putin would surely want to avoid running an election campaign with a rotten economy in the background.

Will they agree?

The big question is whether OPEC and Russia will manage to agree. It should be no more than a cut of five percent to remove the entire global supply surplus, and if it happens, oil prices will likely rise by at least fifty percent.

However, there are two factors that could prevent an agreement. OPEC might not agree on the relative distribution and they also might not trust Russia.

So far, Saudi Arabia has been hesitant, saying that they are only willing to cut if it occurs in a broad coalition that includes Iran. However, the Iranians have so far been barely interested in discussing limitations to their production.

Outlived its role?

The second obstacle is of fundamental nature. The question is whether OPEC should be a swing producer at all, now that shale oil revolution has made the supply side much more elastic.

Saudi Arabia has argued for the last year to let the market balance itself. This strategy is already beginning to pay off.

The US shale oil production has rolled over, while consumption growth has accelerated.

Negotiations in the backroom

Intense negotiations behind the scenes are probably underway these days. It is unlikely that an extraordinary OPEC meeting will be called unless an agreement on terms has already been reached.

It cannot be known with certainty what the outcome will be, but we should get the answer soon. For oil producers, a cut of five percent in exchange for fifty percent higher price appears to be rational and is hard to argue against.

The danger is that the climate of cooperation, especially between Iran and Saudi Arabia, is so bad, that they might instead choose to continue to drown the oil market, resulting in record low prices.

Common sense does not always prevail in the Middle East.

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