OPEC lives for three years

Why the Russian population will pay for the trade war with Saudi Arabia

At the beginning of March 2020, the Russian economy almost simultaneously received a triple blow. First, the medium-term growth cycle (the so-called Juglar cycle of 7–12 years) has ended in the global economy. This in itself favored the emergence of a recession. This was superimposed by the coronovirus epidemic, the peak of which in the EU and the US is yet to come. And in the end, a trade war broke out in the oil market between the Russian Federation and the Kingdom of Saudi Arabia (KSA).

The latter is especially offensive, since there was no need to provoke this conflict. Nevertheless, it was the withdrawal of the Russian Federation from the OPEC + agreement that provoked dramatic events in the oil market. Russia, with a share of about 1.8% of the world economy, cannot influence the dynamics of the medium-term economic cycle, even more so on the coronovirus epidemic, but on its own cooperation with OPEC, it is completely. And even in the event of a deliberate break in the deal (and there are weighty strategic reasons to withdraw from the deal), it was possible to choose a more rational moment for this.

The OPEC+ deal worked quite successfully for three years, which allowed maintaining prices at a comfortable level for oil exporters. The price level established in the market allowed Russia to have a budget surplus and even seriously replenish international reserves. At the same time, a special piquancy is that Russia participated in the agreement only in words - the Russian Federation did not make a real reduction in production. Everything was limited to verbal interventions.

Strategically, any cartel in a competitive market is always unstable. For the OPEC+ deal, the main source of instability was the fact that the participants in the deal were de facto quietly losing their market share to the United States. Oil production in the United States has been growing since 2013, but the reduction in production by the countries participating in the OPEC+ deal made it possible to maintain a comfortable price level. In fact, there was an exchange of market share for fairly high prices.

At the same time, the volumes that had to be sacrificed to maintain the price were quite modest - about 1% of the market per year.

A fee that does not look excessive.

On the eve of Russia's withdrawal from the deal, the KSA proposed to reduce the production of the participants in the OPEC+ deal by another 1.5 mbd, dividing the reduction proportionally among all participants in the deal. This would require Russia to reduce production by about 0.3 mbd (a separate big issue is accounting for condensate in production, but discussion of this issue is beyond the scope of this article). Such a payment for maintaining comfortable oil prices looked reasonable.

Yes, it is impossible to give up market share to competitors indefinitely. But tactically, such a gambit is fully justified: the price has risen much more than the fall in market share. And in order to exit the OPEC + deal, which would certainly take place sooner or later, it is much more reasonable to choose a period of growth in the global economy, when demand for oil is growing steadily. This would minimize the unpleasant consequences in the form of price reduction. And in the case of rapid economic growth, the fall in prices could have been avoided altogether.

But the rejection of the deal in an environment where there was already an excess of supply in the oil market had dramatic consequences: the KSA felt insulted and launched an open price war.

In addition to production growth, very attractive discounts (up to $8 per mbd) are being offered to buyers of Russian oil if they agree to purchase Saudi oil instead of Russian oil.

Unfortunately, Russian and Saudi oil grades are quite similar. This makes them direct competitors. Representatives of Saudi Aramco took advantage of this circumstance, offering their oil instead of Russian. Generous discounts and a significant increase in supply from the KSA did their job: the revenues of Russian companies, as well as their contributions to the federal budget, began to fall.

The true scale of the tragedy will become clear only after a quarter, when the statistics reflect the decline in exports. Nevertheless, even the drop in the price of oil that is available for analysis suggests that Russians are in for severe trials: the ruble has already fallen, inflation will rise following the fall of the ruble, and the expected decline in the Russian economy will spur inflation and unemployment. So Russian citizens have only to drink the full consequences of the decision to withdraw from the OPEC+ deal.

P.S.

Purely theoretically, it can be assumed that Russia will be able to restore the OPEC + deal. But it won't be easy to do so. And the KSA will certainly require additional sacrifices in the form of more production cuts than was offered before the deal collapsed.