A temporary ceasefire, not a long-lasting agreement: Dr. Li-Chen Sim Discusses the OPEC+ Deal

Updated: Apr 30

On 8 March 2020, Saudi Arabia initiated a price war with Russia, facilitating a 65% quarterly fall in the price of oil. The war ended when OPEC+ reached a deal to cut oil production on  April 12. To assess the causes for the outbreak of this conflict, its potential implications for Saudi Arabia, Russia, and other OPEC members and the future prospects of the OPEC+ deal's success, Wikistrat interviewed Dr. Li-Chen Sim.



Dr. Li-Chen is an Assistant Professor at Zayed University (UAE) and an expert on contemporary Russian politics, in particular the impact of oil and nuclear energy on Russia’s foreign policy. Her main area of research concerns the political economy of energy in the Gulf. Her latest co-edited book, External Powers and the Gulf Monarchies was published by Routledge in August 2018.






Insights


  • The OPEC+ deal is a temporary ceasefire: It is unlikely that this deal will last for the next two years, as previous problems with compliance have not been sorted out. Without express rules on oil cut compliance by the G20, this issue will continue to be problematic. Once demand picks up again, after the pandemic, a renewed fight for market share between Russia, Saudi Arabia, and, certainly, shale oil, will ensue.

  • Moscow’s long-term grievances: On Russia's side, there's always been a feeling that by cutting oil production, OPEC+ only propped up US shale oil production, whose market share had ballooned to 18% in 2019, at the expense of OPEC and Russia, whose market share had fallen to 30%. Moscow perceived oil production cuts as unconducive because they just led to the thriving of the shale industry. Beyond that, Moscow was annoyed with Saudi Arabia because it perceived that the Saudis had not been investing enough in Russia, feeling that signed agreements and exchanges of state visits had not amounted to anything concrete.

  • Under-the-radar competition for the Chinese market: Competition for market share between the Russians and the Saudis in China is important, not just because it is the world’s largest market but also because it is experiencing a large demand growth. From 2016 to 2018, Russia surpassed Saudi Arabia as the largest oil supplier to China. But in 2019, through a series of investment deals with Chinese refineries, Saudi Arabia actually managed to relegate Russia to second place. Moscow, thus, wanted to try as much as possible to push out Saudi Arabia from China, while at the same time attempting to reduce the dominance of shale oil in the market.

  • Recognition of miscalculation was an incentive to push for the deal: Neither side thought that oil prices would plunge as low as they have. They probably thought that prices might stabilize in the mid-30s, but certainly not plunge down to the 20s. The IEA's Fatih Birol stated that, due to the fall in oil demand, prices could go down to $15 and less. This certainly led to the conviction that there had been a miscalculation, leading to the question of whether continuing on such a path was a viable way forward.

Transcript:


Wikistrat: As you probably know, we have recently seen a standoff in this conflict: a deal has been reached regarding the oil price war. Would you like to give us the broader picture of the war? How did the oil price war between Saudi Arabia and Russia start? And what led to this war?


Li-Chen Sim: Let's start with the immediate facts. I'm sure you're aware that during the meeting in March, Saudi Arabia wanted to cut the oil production quotas even further, whereas Russia did not want to do that; they wanted to just simply extend the current oil price agreement. Apparently, it was too big of a gulf to bridge, hence there was no agreement at all. This is what started the oil price war. That was the narrow picture of what happened.


But, we need to take a step back to look at the broader picture, because although that was a short-term kind of disagreement, there are lots of long-term factors, which explain why this kind of oil production agreement was unstable in the first place. On Russia's side, it was always very obvious that there was consistent discomfort with regard to oil production cuts. Even in 2017, when the cuts began, there were a lot of murmurings of discontent about having to be part of this on behalf of Russia. Top oil officials sent letters. Igor Sechin, who is both the Deputy Prime Minister and the boss of Rosneft, sent a letter in February 2019 formally expressing his displeasure, but he was not the first and certainly not the last one to voice discontent, because there's always been a feeling that by cutting oil production, OPEC+ only propped up US shale oil production, which has been taking over a progressively larger share from OPEC and from Russia, in general.


If we look at shale oil, the market share was maybe 9% in 2008, and by last year, 2019, it had ballooned to about 17, 18%, whereas OPEC's share of the world's oil production market had fallen from around 34% to 30%. So, there's the feeling in Russia that oil production cuts were unconducive because they just let shale oil survive and even increase their market share.


Another long-term factor, from my point of view, was the fact that the Russians were partially annoyed with Saudi Arabia for various reasons. Moscow perceived, for example, the Saudis had not been investing enough in Russia. There was some feeling that there were a lot of agreements signed between the two parties after exchanges of state visits, but that these agreements had not amounted to anything concrete. Further, Moscow had been irritated by the Saudis calling out Russians producers on the fact that they had not effectively reduced production to the extent that they had promised to cut. So, there were these kinds of long-term irritation as well on the part of Russia.


On the part of Saudi Arabia, I think that we still need to understand that long-term-wise, they were also a little bit annoyed with Russia's obvious lack of compliance with some of these cuts. Although, in general, OPEC has complied with the cuts almost 100%, and even they have cut more than they're required to, Russians have generally cut only about 80% of what they've promised, in general, throughout these two years. So, there's a feeling that the Russians need to step up and comply with agreements because Riyadh was taking on a larger share of the burden. This was a source of irritation for Saudi Arabia – Riyadh felt that it wasn't really an equal partnership which reflected in symmetric oil production cuts. By considering long-term factors, the two sides were in a kind of a disconnect.


A very important short-term factor instead were the different assessments about the coronavirus in China. On Russia's part, Moscow felt that the coronavirus situation was not going to really destroy global demand to the same level as Saudi Arabia's assessment because, don't forget, at this time, COVID had not really hit Russia. It had not really hit the developed world, US, and Europe. It was in full swing, obviously, in China and Southeast Asia, and it had already started to spread in the Middle East. But Russia, at this point in time, in early March, was kind of spared from much of the worst of it; it had just maybe a handful of cases at this point, and certainly not in the Western part of the country.


Thus, Russia felt that there wasn't really a need to cut as much as Saudi Arabia wanted, proposing to just extend the agreement and reconsider whether an actual cut would be needed in June, if there was demand destruction. Whereas from Saudi Arabia's point of view, they disagreed, feeling that there was going to be huge demand destruction because of the dire situation China was in, and hence they had to cut oil production.


Wikistrat: How do you see Russia's strategy and its objectives beneath that standoff? What was Moscow really trying to achieve in this confrontation with Saudi Arabia, regarding the oil price war?


Li-Chen Sim: With regards to that strategy in Saudi Arabia, Russia was unhappy with how Saudi Arabia was dealing with the shale oil challenge. So, its strategy has been to try to destroy shale oil because they were trying to do that with the original agreement in 2016; obviously, it didn't work because shale oil came back stronger. This time around, Russia felt it really had to destroy US shale oil once and for all by launching an oil price war.


Now, that would strategically put some kind of wedge between Saudi Arabia and the US, which have been traditional allies for quite a while, and it was in Moscow’s intentions to do so. Saudi Arabia appreciated that this was part of Russia's strategy because the Foreign Minister of Saudi Arabia, as well as the Energy Minister, came up very strongly in the past few weeks to tell Russia that the country didn’t want to be pulled in Moscow’s war with US shale producers, saying that the country has nothing against US shale oil. They put it in this way: this is not a sheik versus shale problem, it's your problem, it’s a tsar versus shale issue.


So I think Saudi Arabia has been very conscious in trying to say, "Do not drag us into this whole oil price war," whereas Russia has taken on shale, but at the same time trying to win back market share that it has lost both to US shale and to Saudi Arabia as well.


Where does the Saudi Arabia market share loss come in? Well, most obviously in China. In China, for instance, with the exception of 2019, for the past three years, 2016 to 2018, Russia surpassed Saudi Arabia as the largest oil supplier to China, so it increased its market share there. But in 2019, through a series of investment deals with Chinese refineries, Saudi Arabia actually managed to grab back top spot and relegated Russia to second place.


Of course, China is the world's largest market. So, the market share issue in China is important, not just because it is a large market, but also because it is experiencing a large demand growth. It is, therefore, a very important place for competition between these top oil producers. From Russia's perspective, it wanted to try as much as possible to push out Saudi Arabia from China, while at the same time attempting to reduce the dominance of shale oil in the market. Moscow was prepared to launch this kind of oil price war, its financials were actually quite stable, certainly more than in 2016 or 2014. It felt [it possessed] the financial wherewithal to withstand what could be a long but certainly a brutal oil price war with Saudi Arabia, on the one hand, and with US shale on the other.


Wikistrat: What do you see as Saudi Arabia's strategy and objectives that they tried to achieve in this standoff with Russia?


Li-Chen Sim: What they really wanted was to get the Russians back to the negotiating table. I don't think Riyadh wanted an oil price war at all, but it felt that it had no choice but to launch one as a way of upping the ante, making it hurt so bad that the Russians would come back to the table. Therefore, it launched this oil price war, trying to make it as painful as possible by just flooding the market with huge amounts of oil. This was a Saudi strategy that had been used repeatedly before. There have been a few of these oil price wars before; in 1986, for example, and in the late 1990s, Riyadh used the same strategy with respect to Venezuela. Saudi Arabia has used this strategy of flooding the market before, in order to enforce oil supply discipline.


I believe that the Kingdom thought that it could work again, in this way trying to force Russia to come back to the table with the threat of rock bottom oil prices, that was its strategy in trying to flood the market. But we have to probably understand that it's one thing to have a strategy, but sometimes miscalculation occurs on both sides. I do not believe that either side thought that oil prices would plunge as low as they have, in the 20s. They probably thought that it might stabilize in the mid-30s, but certainly not plunge down to the 20s. Some Russian officials wanted to repair, wanted to get back to an oil price agreement, even saying, "If you don't have an oil agreement, it would plunge as low as $10 a barrel." This focused their attention.


Goldman Sachs, for example, or the IEA's Fatih Birol stated that oil demand could fall as much as 20 million barrels, 30 million barrels, so it could go down to $15 and less. This certainly led to the conviction that there had been a miscalculation, leading to the question of whether continuing on such a path was a viable way forward. Certainly $20, $15, $10 per barrel oil would have become a little bit too painful. We have to appreciate there could have been an element of miscalculation in the oil price war, as well; not just a strategy, but also some kind of miscalculation.


Wikistrat: How do you see this tension between Russia and Saudi Arabia really affecting other OPEC members, particularly the UAE and Iran?


Li-Chen Sim: Let's start with the case of Oman, which is probably one of the more affected members in the Gulf. As you know, they're not OPEC members. They have been quite badly affected by this low oil price. Already, Oman doesn't really produce all that much oil, but it is rather dependent on high oil prices. It's trying to diversify its economy, especially through high-end tourism. So, it has been borrowing a lot to try to eke out whatever oil it has left. It has been on the debt markets, borrowing from banks, so it already had quite a high level of debt.


Now, with this oil price war and lower oil prices, it's going to be even more highly indebted. Some of these banks have already downgraded it slightly as a result of this oil price war. The country is going to be in some trouble, given that they're going to have to pay back some of these interest and installments, and it rests to be seen whether they can actually do so, when these become due in the next few years. That's going to be quite a big problem for Oman.


Bahrain also faces a similar kind of problem. But in Bahrain, at least, some of the Gulf states, like Saudi Arabia and the UAE, extended bailout packages to the country even before the oil crisis. Hopefully, they will continue to receive this kind of support.

Now, the UAE has also been affected, obviously, by low oil prices. Luckily for the UAE, at least, while the country surely continues to depend, quite a bit, on oil revenues, it doesn’t to the extent of Saudi Arabia, where roughly, 70-80% of the government revenues come from oil. That figure is much less, around maybe two-thirds for the UAE last year. But where the UAE may be hit by the low oil price environment and demand destruction is also in Dubai, where there is tourism, there are hubs for logistics, for re-export trade, real estate, and financial services. All this can get hit significantly, in terms of demand destruction, in terms of all these COVID measures, including restriction of movements, flying, and traveling in general.


It's not, therefore, surprising that the UAE has put out a stimulus package to try to ease some of the strains, but I think the UAE will weather this low oil price environment because of its vast financial resources. It has its own resources, obviously, through the sovereign wealth fund, but it can also borrow from banks, and banks are happy to lend to Abu Dhabi. I don't think it has a problem in this regard. Dubai, if facing a problem, can always get a bailout, hopefully not too high a price from Abu Dhabi. In short, there are measures that the UAE can take.

When it comes to Iran, however, the country is under sanctions. Low oil prices and demand destruction are not going to do Teheran any favors. China's reluctance to touch some of this covertly shipped oil does not help the situation. It doesn't have as strong a financial buffer system as other Gulf states. So, it's not a pretty picture for Iran. But I guess there is a silver lining, in that it is excluded from the OPEC+ restrictions.


Wikistrat: How do you see COVID-19 impacting the relations between different players in this conflict, looking at the weeks and the months ahead?


Li-Chen Sim: Apart from the oil price slide, COVID-19 is terrible, but it has come as quite a good opportunity for some of these countries to rebuild some of these relations. For example, the UAE has been reaching out to Iran, even before the oil price slide and COVID-19 to try to potentially build subtle bridges to Iran, and the UAE has taken the advantage of COVID-19 to send medical help. They've used the opportunity of COVID-19 to try to extend more bridges to Iran, which is a good thing for peace.


Russia has also tried to engage in what you can call COVID diplomacy or medical diplomacy, by sending shipments of medical equipment to Europe, and [especially] to Italy. This is an example of trying to smooth things over, to paint a nice PR picture of Russia to one of its bigger oil customers. Italy is quite an important oil customer for Russia. I guess what it's trying to say is, "Look, I know a flood of Saudi oil could come your way. I know the Americans are also trying to get into the oil market in Europe [but] don't forget that we've kind of helped you out in this crisis, as well."


There's a lot of PR or diplomatic opportunities with regards to COVID itself, but also to the oil price environment, as I mentioned before, a lot of PR going on with Saudi Arabia trying to say to the US, "Look, it's not us, don't blame us. It's the Russians who are trying to get rid of you."


I found it really interesting that the Saudi Energy Minister spent a couple of hours talking with US Republican senators, briefing them about the OPEC+ agreements. This is not the Saudi Energy Minister talking to Trump, but talking to influential Republican senators. So again, there's quite a lot of this bridge-building, fence-mending diplomacy going around, not just with regards to COVID, but also with regards to this oil price war. Countries see this as a terrible thing, but also as an opportunity. There's a silver lining there, and they're going to grab whatever they can to try to mend fences.


Wikistrat: In your assessment, which other factors are influencing this situation? Are there any hidden factors that are not discussed by the media, which you see as driving these tensions that are not really getting the attention they deserve?


Li-Chen Sim: We know that Saudi Arabia has discounted oil for market share competition in Europe, we know they are competing for US political favors, we have seen the Saudis are trying to smooth things over with the Republican senators or the US shale oil industry.

The Russians are also trying to wrangle some kind of sanction relief from the US. They've actually done so quite under the radar because everybody's been focused on COVID and the oil price war.

At the same time, the Russians are also trying to wrangle some kind of sanction relief from the US. They've actually done so quite under the radar because everybody's been focused on COVID and the oil price war. Something that has gone unnoticed is that Rosneft, one of the big Russian oil companies, has actually managed to offload its toxic Venezuela oil assets. They are “toxic” because Rosneft's trading arms have been sanctioned by the US for apparently propping up the Maduro regime.


In recent days, Rosneft has actually managed to offload its Venezuelan activities to the Russian state, by selling them off to the Kremlin. In so doing, there is the hope that the US will then lift sanctions on Rosneft's trading arms, which would allow it in turn to then sell its oil to China because, prior to this, China had refused to take Rosneft's cargo from Venezuela. If Russia agrees to step into the new oil agreement, the US may consider lifting sanctions on Rosneft's trading arms that have been sanctioned.


This greased the agreements, something which quite a lot of people have not picked up on. It's important because Igor Sechin is the head of Rosneft, and he was one of the most vociferous opponents of Russia entering into any kind of oil cut agreement with Saudi Arabia. He was the one that wrote a letter to Putin, saying that Russia should exit the agreement on the grounds that it propped up the shale industry. In my estimation, this was kind of a sweetener to Sechin, "The US will probably stop sanctioning you if you get out of Venezuela. So, maybe, in return, could you just not object so much to this oil agreement?" In return, Sechin gets a bigger control over Rosneft, the Russian government's stake in Rosneft falls from a majority stake to about 40%, which is good news for Igor Sechin. This is one of the things that have not been really highlighted about the new oil agreement.


To go back to your question about what has underlined the disagreements between Russia and Saudi Arabia, the news has failed to look at the matter from the China angle, the fact that these two are competing for the Chinese market. They are quite fierce rivals in China, as I've mentioned. It's a really important market. They both bring different things to the China market, in terms of rivalry; Saudi Arabia is cheaper in terms of its operating costs, but Russia brings to it a route that basically bypasses the seaborne cargo – Russia exports its oil to China via the ESPO pipelines, giving additional security to China, which is worried about its vulnerability in seaborne oil cargos.


They both compete for this share of the China market in very different ways. Saudi Arabia has bought into Chinese oil refineries, in the hope, with the agreement, that the Chinese oil refineries would then lock in sales of Saudi crude, thus locking up more of the Chinese oil demand. Saudi Arabia with its money and Russia with its pipelines rather than seaborne cargo, thus, used different strategies and strengths to try to win a bigger share of the booming Chinese market. That rivalry is quite a big one that has not really featured a lot in talking about the disagreements between the two countries.


Wikistrat: China here is not so much a player; it is a market affected by this competition, but it's not actually involved in this standoff.


Li-Chen Sim: Yes, that's correct. It's not directly involved in the standoff. Both countries have, however, come up with different assessments over how and what is the extent of the Chinese demand destruction. Russia, as I mentioned before, feels that there's going to be a faster rebound in China. But, perhaps, in Saudi Arabia, they feel that the rebound may take longer because China's obviously more connected to the rest of the world in terms of its intermediary role in the global supply chain. If there is no demand in Europe or the US for the finished products, then obviously there's less demand for the intermediary products that China produces. This different assessment, in that sense, makes China a factor in how much they should cut, whether they should cut or wait and see what happens in China. They both compete for the China market, but they also have different assessments over China's role in this whole demand destruction scenario.


Wikistrat: Are there other players involved here, in terms of personalities, financing operations, any other players involved in this conflict, that are under the radar and don't get much attention in the media coverage of this conflict?


Li-Chen Sim: I could probably think of two – the UAE and Mexico. Abu Dhabi’s role in the conflict is a really interesting one because it has actually tried to bring both sides together. It's been very invested in trying to smooth over the differences between Saudi Arabia and Russia. For example, it was the one that was really enthusiastic in thinking that the March agreements would be achieved. Its Energy Minister came on and expressed confidence in the success of negotiations, which then failed.


Then, in recent weeks, it has come up quite strongly to express the need for a new oil agreement. Its role is really interesting because it's obviously a close Gulf ally to Saudi Arabia, with its military participation in Yemen, and in Syria. But also, it's the closest Gulf state, at least on paper, to Russia. It has signed a strategic partnership, becoming the largest trading partner for Russia in the Gulf. As such, it occupies an interesting intermediary position that allows it to speak out or try to persuade Russia, as well as Saudi Arabia, to come to the agreement that we had in the past few days.


The reasons why it's doing so are partly because its economy is taking quite a hit from all this demand destruction and from COVID. Its stimulus package, for example, ranges between 5-8% of GDP. It's bigger than the stimulus package from Saudi Arabia, not as big as Bahrain, because Bahrain is in a worse-off condition, but still, it knows that it recognized the need to act promptly to resolve the situation. The other interesting actor in all this, which has flown under the radar, is Mexico.


Why is Mexico one of the factors in the consideration of this whole situation? Well, Mexico is an OPEC+ member. After Russia, it is the second-largest non-OPEC participant in the whole OPEC+ agreement, with its production amounting to about 4% of OPEC+ oil volumes. That's why it's been quite important to get Mexico into the agreement.


Mexico is also quite an interesting actor because in earlier iterations of this agreement last week, OPEC did come out to say that the new agreement hinged on Mexico's agreement to be part of this whole new OPEC+ agreement. They wanted Mexico to cut about 400,000 barrels. Mexico stated its willingness to cut only 100,000 barrels and OPEC responded that, without Mexico’s adherence, the whole deal would have been called off. It was quite interesting to see Mexico being perceived as a make-or-break factor. Whether this is actually posturing is a different question and remains to be seen. One of the strategies was to impose certain cuts on Mexico notwithstanding, with the reassurance that the US would have stepped in, in case Mexico refused to undertake the proposed production cuts.

It was quite interesting to see Mexico being perceived as a make-or-break factor. Whether this is actually posturing is a different question and remains to be seen.

Obviously, the US is a big actor, certainly not one that has acted under the radar. Washington played a huge role in bringing the two sides together, whether through direct or indirect pressure.


Wikistrat: In your assessment, what is expected to happen in this conflict in the coming months? So far, this seems to be a temporary ceasefire.


Li-Chen Sim: Yes, you've hit the nail on the head. It is a temporary ceasefire, an armistice, a truce. I don't see it as being a long-lasting agreement for the next two years, which is what the shelf life of the agreement was supposed to be, for various reasons. Firstly, many analysts feel that the cuts are simply not deep enough; it's not going to push the oil price back above $40. It may stop it from falling to $10, but it's not going to push the oil price back to levels which they are both probably more comfortable with. Why? Because the previous problems with compliance have not been sorted out. In the previous iteration of it, the OPEC was expecting the G20 to formulate a monitoring rule about oil cut compliance, but nothing has been said about G20's rule on such matters. The compliance issue will still dog the participants in the process, in particular Russia, and this is still going to create tensions between the OPEC and OPEC+ partners.


At least OPEC will be happy with this agreement, in the sense that it shows that OPEC is still relatively relevant.

This truce is going to be short-lived as well, because once demand picks up again, once the whole COVID thing eases and demand picks up again, which many expect to be around the third quarter, then I think we can see a renewed fight for market share between the US, Saudi Arabia, and certainly shale oil because they would be happier with the slightly higher oil prices. There will be a fight for market share again, for the demand that will pick up in the third quarter. So, once again, there's going to be market share slashed oil prices, I really don't see a situation where everybody is happy with each other. I think there will still be conflict.


I do, however, think that at least OPEC will be happy with this agreement, in the sense that it shows that OPEC is still relatively relevant. For the past month, people have been saying OPEC clearly is no longer relevant if it cannot control oil prices, since they have gone to the bottom. But I think this agreement, although it was not the 15 million barrels that Trump wanted or the 13 million that Goldman Sachs thought would be good for the market, at least shows that OPEC and OPEC+ still have some control over the oil market. Not too much control, but at least enough to stop prices from going to $10. I don't think that oil prices will go over $40, but I don't think they will jump to a bottom, $10, either. There is a little bit of a boost from this, so I think that's how it'll play out.


Now, the Russian angle is quite interesting because of some of the early Russian reactions to this new oil deal. For example, those who wanted an oil agreement in the first place are now saying, "Yeah, okay, we will accept this new oil agreement. But you know what? It's a horrible oil agreement. It's like a capitulation for Russia. It's a bad thing for us, but we have to do it. We, the oil companies, have to bear with it because this is better for the wider picture." What that wider picture will turn out to be, it's going to be really interesting to watch because there could have been deals that have not come to light about what Russia gave to the Saudis to come to the table, what the Saudis gave to the Russians, or what the Americans did to nod heads together, what they gave into the Americans. In the next few weeks, maybe some of these sweeteners will come to light.


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