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OPEC and non-OPEC pact exit strategies: Saudi, Russia alliance is ‘thicker than oil’

The recent announcement by Saudi Crown Prince Mohammed bin Salman during his recent US visit that the Kingdom is looking at a long term relationship between Saudi Arabia and Russia, extending from 10 to 20 years, has taken the markets by surprise.

Everyone’s attention had been fixed on whether the current full year 2018 OPEC and non OPEC production cut agreement will be renewed in 2019, or reversed or a new short term mechanism is put in its place.

The Saudi Prince’s comments seems to have dispelled a short term, year by year approach and has opted for a longer lasting energy relationship with Russia giving credence to the saying that the existing relationship between the two countries is deeper and the alliance or confluence of self interest is indeed “thicker than oil”.

Any so-called “exit strategy” from the November 2016 Vienna agreement for the 24 OPEC and non OPEC oil output cuts is going to be a crucial policy decision that carries far larger implications than just for Saudi Arabia, Russia, or OPEC, but the global economy and the monetary policies of both the European Central Bank and the US’s Federal Reserve: what would be the impact of another oil price collapse or spike, as opposed to a measured, gradual increase in the price of crude oil that more or less is aligned with a balance between supply and demand?

Getting it right is crucial for all sides to avoid another bout of economic recession or high inflation and this is where the Crown Prince’s statement becomes more important.

The fine tuning of a successful exit strategy is also important for the next stage of the energy geo- political relationship built between Russia and Saudi Arabia and how both sides see the exit game of the current OPEC plus agreement due to expire at the end of 2018.

The questions are many and the answers are still few and sketchy – will the agreement be extended or not? If not, how will a successful exit mechanism be set in motion with success defined more broadly to take account of both consumer nations and producer nations agendas.

Will it be first in – last out type of scenario for the major oil producers like Russia and the Gulf states that allows the smaller fiscally stressed oil producers to start ramping up production, if they have the spare capacity and have invested in this spare capacity over the past few years? These are big ‘ifs’. Again, the Crown Prince’s statement for a long term vision of the energy market has set a new marker for the OPEC plus alliance.

OPEC producers and others who have joined the production agreement can learn from the experience of Central Banks in managing their own policy exit strategies

Dr. Mohamed Ramady

Learning from experience

OPEC producers and others who have joined the production agreement can learn from the experience of Central Banks in managing their own policy exit strategies. Indeed, it is striking how much Saudi and other oil policy officials sound like central bankers these days when they talk about “rebalancing” the supply and demand of crude oil or an “equilibrium” price.

As Saudi Energy Minister Khaled al-Falih recently remarked, a willingness to “overshoot” the crude oil equilibrium price for a while; that sounds an awful lot like Fed officials describing their willingness to tolerate a “temporary” overshoot of the Fed’s 2 percent inflation target, as this was the main target matrix for a successful Fed policy , just like one of OPEC’s success targets is to ensure that oil prices remain within “reasonable levels” and do not erratically overshoot.

Much of the thinking going into devising a successful OPEC exit strategy is in fact borrowed straight out of the USA’s Federal Reserve playbook with the famous “taper” when it exited its Quantitative Easing (QE3) Large Scale Asset Purchase Program beginning in 2014.

Looking back over the period, the Fed successfully achieved its exit from QE, despite the difficulties of crafting a policy consensus among 19 members of the Federal Open Market Committee who held widely differing views on the economic outlook, the nature of inflation dynamics, and indeed the merits of QE itself.

But its most pressing challenge was in communicating the policy of the taper convincingly to the markets. The Fed learned its lesson when the reverse tapering back fired – that communications and the “signal” was as or more important than the actual tapering of the bond purchases – and OPEC may do well to heed the same lesson.

This however will not be as easy as the problems faced by the Fed in having to deal with an internal constituency as there are 23 OPEC and non-OPEC members to the pact, but in reality there are only two that matter – Russia and Saudi Arabia and how these two manage the exit, if any, will set the agenda for the others despite some Iranian reservations.

The appointment of an anti -Iranian neo -con hawk John Bolton as the new US National Security Advisor adds another dimension. If the Iran Nuclear agreement is abandoned and fresh sanctions are imposed on Iran, or a military clash takes place between the USA and Iran, given Bolton’s public statements of favouring bombing Iran, then the current pact could well unravel if oil prices go well beyond the $ 70 per barrel or $80 levels.

Any tapering of the output cuts, essentially a reverse taper, is likely to come only after a long period of messaging its framework and some of its operational details to ensure as smooth an effect on crude prices as possible.

That would suggest first discussing the Exit at the 2018 June OPEC meeting to begin shaping the internal consensus, followed by several months of preparing the markets, and perhaps its formal adoption at the November OPEC Ministerial meeting for a taper that begins in 2019. The Crown Prince’s statement has added a bit more certainty of long-term intentions.

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Dr. Mohamed Ramady is an energy economist and geo political expert on the GCC and former Professor at King Fahd University of Petroleum and Minerals, Dhahran, Saudi Arabia and co-author of ‘OPEC in a Post-shale world – where to next?’ His latest book is on ‘Saudi Aramco 2030: Post IPO challenges’.

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Last Update: Tuesday, 10 April 2018 KSA 01:02 - GMT 22:02
Disclaimer: Views expressed by writers in this section are their own and do not reflect Al Arabiya English's point-of-view.
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