Russia and OPEC: Will the Relation Last?

October 26, 2017
Russia and OPEC: Will the Relation Last?
Nikolay Kozhanov
Nikolay Kozhanov Non-Resident Fellow in International Relations and Political Economy

On August 28, 2017, the Wall Street Journal reported about the readiness of Russia and Saudi Arabia to push for the extension of the OPEC+ agreement beyond March 2018. This treaty involves both the OPEC and non-OPEC members who, in 2016, agreed to decrease their oil production in order to encourage the growth of oil prices on the international market. However, the proclaimed intention to support the continuation of the deal’s implementation, beyond the initially set deadline, should not be considered as the final decision of the Russian leadership. In July 2017, the participants of the OPEC+ members’ ministerial meeting in St.Petersburg did touch upon the issue of deal’s extension. Yet, it seems that the discussion of this issue was rather Riyadh’s than Moscow’s initiative. Indeed, Russian Minister of Energy Aleksandr Novak confirmed that nothing is excluded as an option for Russia. Nevertheless, he avoided answering direct questions on whether the OPEC+ agreement will be extended beyond March 2018 and what the Russian stance on this issue is. Such behaviour of the minister is an obvious sign that he is not sure whether the Kremlin will retain its interest in the deal extension. And there are certain reasons for this.

The End of Illusions

With the drop in oil prices Russia actively tried to achieve coordination with the Middle Eastern oil producers in order to stabilize the situation in the market and boost oil prices. Consequently, after decades of negligence, Russia established closer relations with OPEC and its Middle Eastern members. In December 2016, Moscow became a participant of the OPEC+ agreement. In May 2017, it supported the extensions of the deal till March 2018. In spite of domestic opposition to the agreement and periodical attempts of Russian oil producers to break the limits set by it, Russia (as of August-September 2017) has been relatively loyal to the principles of the deal.  Yet, experts argue that Russian loyalty to the principles of the deal might not last long and call Russia one of the countries that are possibly least interested in its further extension.

Indeed, the Kremlin’s attitude to the deal might change. As opposed to statements by Russian officials in December 2016 or even May 2017, the Russian leadership seems to be less enthusiastic about the deal’s future. As already been, the deal’s key supporter in the Russian government, Minister Novak, is reluctant to give any clear predictions about the future of the deal beyond March 2018. For now, Moscow believes that the implementation period of the OPEC+ agreement till March 2018 as optimal, and the main task is to ensure that the deal will stay in force till that day. Meanwhile, some Russian oil majors left their investments plans largely unchanged, although cuts of expenditures on new projects would be logical if corporations believed that the deal will continue.  The clearest examples are Lukoil and Rosneft. By July 2017, these companies continued to prepare themselves for the end of the OPEC+ deal. Thus, the volume of Rosneft’s production drilling increased by 22% in the first six months of 2017 as compared to 2016. In the case of Lukoil, this figure was 26.5%. There was also a substantial increase in spending on exploration works (approximately by 20%). In general, according to the analysts of Sberbank, a leading and oldest Russian bank, if necessary, Russia is ready to increase the oil production from the current 10.95 million b/d to 11.2 million b/d in 2018 with the potential further increase to 11.6 million b/d in 2019.

Nevertheless, if Russia decides to extend its participation in the OPEC+ deal beyond March 2018, supporters of the deal in the Russian government will definitely have problems with getting unanimous approval of the deal. First of all, there is certain disillusionment among Russian business regarding the effect of the deal on oil prices. The implementation of the OPEC+ deal managed to stabilize the price of oil, but the price level still remains lower than was initially expected. Russian oil and gas companies should also be concerned that the extension of the deal might negatively affect their plans to launch new projects aimed at the increase in domestic oil output for the period of 2019-2025. Apart from this, experts believe that, while being unable to substantially increase their profit, the OPEC+ deal created additional opportunities for those Russian rivals in the energy market who decided not to join the agreement.

The Russian authorities, in their turn, are concerned about ‘cheaters’, countries that do not comply with the initially agreed norms of decrease in oil production, such as Iraq and Kazakhstan. Moscow blames them for the undermining of the positive effect of the OPEC+ deal on oil prices. Russia also considers ‘renegades’ producers such as Nigeria and Libya, OPEC members that are exempt from the deal’s limitations in output, but who are not necessarily adhering to the spirt and objectives of the deal.  From the Russian view, if there is no improvement in the discipline of other OPEC+ deal members within the next seven months, this may discourage Russia from agreeing to an extension of the deal.

Russian Presidential Elections and the OPEC+ Deal

However, the negative economic factors that might compel Moscow to quit the OPEC+ agreement are counterbalanced by a number of socio-political factors that unexpectedly strengthen the Russian motivation to stay with the deal.  First of all, Russia is preparing for the presidential elections that are supposed to take place in March 2018.  Thus, the Russian authorities will try to win the support of the low layers of the population via the implementation of extended social programs. For instance, in 2018, Moscow plans to launch the food coupon program for low-income families that will cover up to 15-16 million people. Although each person under this program will receive less than 30 USD per month to buy additional foodstuff, the annual volume of assets allocated for this program will be high for the Russian budget – about USD 4 bln. Given that oil revenues represent the main source of Russian income, the high prices on oil are important to ensure financing for the implementation of such government social programs.

The oil-reliant Russian economy is susceptible to fluctuations of oil prices, whose change immediately affects the key macroeconomic parameters of the Russian economy such as the GDP growth, inflation and ruble exchange rates.  With a view to the 2018 elections, it is also important for the government to demonstrate normal/good economic performance and, thus, to show to the population the ability to deliver on promises of economic growth. It is notable that, in the late spring of 2017, the Russian Ministry of Economic Development recalculated its prognoses for the rest of 2017 based on the assumption that the oil deal is extended till the beginning of 2018. Thus, in May-June 2017, the Russian government predicted the inflation at the level of 3.8% instead of initially expected 4%. It also expected that the budget deficit can be below 2% (predicted in the beginning of 2017) whereas high oil prices would allow Moscow to depreciate the ruble by 2018 from 57 rubles per US dollar in May 2017, to 62-64 rubles per dollar by the end of the year; instead of initially planned 68 rubles to the dollar by the beginning of 2018. In the late-August 2017, the Russian Ministry of Economic Development further improved its prognoses regarding ruble performance. Its experts argued that the ruble-dollar exchange rate in 2017 will be 59.7 rubles for 1 US dollar instead of initially expected 64.2 whereas, in 2018, 1 US dollar will cost 64.7 rubles instead of the previously expected 69.8. Consequently, the proponents of the OPEC+ deal in the Kremlin got a serious argument in favor of further extension of the deal.

Finally, Moscow remains interested in building up the economic union of the post-Soviet republics through the Eurasian Economic Union (EEU). To make membership appealing for current non-members, the Kremlin needs to demonstrate that the formation of the EEU resulted in the growth of the economies of those post-Soviet republics that have joined the EEU.  Given that Russia is the locomotive of the EEU’s economic development, the higher oil prices that boost the development of the Russian economy is also seen in the Kremlin as a guarantee of the EEU’s future. Consequently, Russia will do its best to keep oil prices up, as well as to keep Kazakhstan the part of the OPEC+ deal.

After March 2018

Nevertheless, Moscow does not see the deal as something it wants to keep forever. March 2018 can be the end date of Russian participation in the OPEC+ agreement if the Kremlin considers that oil prices are stabilized, at a relatively high level that is suitable, with no clear prospect of falling.  Under these circumstances, Russia might not extend the deal for the third round. First of all, Moscow will need to take into account the interests of its oil producers. They accepted the conditions of the OPEC+ deal, but it does not mean that they like the deal. On the contrary, the Russian oil producers supported this deal only as a necessity and they will be happy to get rid of it as soon as possible. By March 2018, Russia will also pass the crucial elections phase and the expensive election campaigning will be over.

So far, the Kremlin seems not to know itself whether the extension of the OPEC+ deal is in its interests or not. Lots will depend on the situation in the oil market that remains extremely volatile. Under these circumstances, the decision on the extension of the deal will probably be taken no early than  December 2017 – January 2018 when it will be possible to predict how the oil market will be developing in the first months of 2018. Moreover, the more volatile the oil market may be in the coming months, the shorter the period will be for when Russia decides on its further participation in the OPEC+ agreement. Under these circumstances, the Wall Street Journal’s conclusions that Russia will support the extension of the deal beyond March 2018 might be a bit premature.

The statements by Minister Novak that the extension option is not excluded were probably determined by the following reasons. On the one hand, the Russian leadership wants keep windows of opportunities open. Consequently, it discusses the OPEC+ deal’s extension with the Saudis and other OPEC+ members to know their opinion and to be able to initiate the extension of the deal when the Kremlin decides that this is in its interests. Moreover, in mid-September, the predictions of Russian experts regarding the oil market in 2018 were not that bright. For instance, according to the head of the Russian Central Bank, Elvira Nabiullina, during the first six months of 2018, the oil prices might fall, and the barrel of oil will be traded at the level of USD40. She also argued that the probability that the price of oil will stay at the level of USD40 till the end of 2018 will be higher if the OPEC+ deal is not extended. It is notable that the Russian Ministry of Economic Development is also not overly positive about the situation for oil prices. According to its experts, oil prices will be stable for the first six months of 2018 (potentially they will stay in the corridor of USD50 – 60), but, during July – December 2018, the Ministry expects that prices may start falling.

On the other hand, Russia has a concern on how things will play out with the end of the deal will look like. Minister Novak said, that it is necessary to make a smooth exit from the agreement so that the end of its implementation would not cause a shock in the market leading to the fall of oil prices. Consequently, Russia might conclude that in March 2018 it will initiate the extension of the deal for the last time and provide a minimal period to allow oil traders to adjust their plans and strategies. From this point of view, an extension for three more months may be just a part of the exit strategy. And Moscow is still unsure on whether it needs this extension.

Currently, the future of the Russian participation in the OPEC+ deal is unclear. The above-mentioned political factors can only guarantee that, as long as the current extension of the OPEC+ deal lasts till March 2018 and the agreement can still affect the oil prices, Moscow will retain its interest in keeping the agreement in force. Moscow will also retain strong interest in talking to the Middle Eastern participants of OPEC making necessary adjustments in its political relations with them.