Market Insider

Russia's reluctance for a production cut exposes possible crack in three-year-old OPEC alliance

Key Points
  • Russia has not so far endorsed a recommendation from a technical committee for OPEC and its allies to deepen production cuts. Oil analysts said it shows a possible lack of harmony in the producers' alliance.
  • The technical committee monitoring the market and production for OPEC+ recommended a 600,000 barrel a day additional cut to stabilize the market.
  • The impact of the coronavirus on transportation in China and elsewhere has dealt a serious blow to the oil market, which could see demand drop by 1 million to 2 million barrels a day temporarily.
Russian President Vladimir Putin chairs a meeting with members of the government in Moscow, Russia, on February 5, 2020.
Aleksey Nikolskyi | Sputnik | Kremlin | Reuters

Russia's reluctance to jump on board a bigger OPEC production cut may signal a potential fissure within the oil producer alliance, known as OPEC plus.

Led by Saudi Arabia, other OPEC producers and Russia were considering an emergency meeting to cut production in response to the impact of the coronavirus, but it's not now clear whether that will happen.

A committee advising the producers met for three days in Vienna and on Thursday recommended a 600,000 barrel a day reduction in production to bring relief to the oil market, according to reports. The Joint Technical Committee, made up of representatives of producing countries, is not a decision making entity, and it only makes recommendations to the ministers of OPEC countries and its allies, including Russia.

However, Russian Energy Minister Alexander Novak said time is needed to weigh any impact on the oil market from the virus, which has led to a steep decline in energy demand due to a massive shutdown of transportation within China and elsewhere.

OPEC's regular meeting is set for March 5, but there were expectations it could hold an emergency session with Russia and other non OPEC allies next week. An earlier meeting was still possible, but there has been no announcement.

"The optics are not great. You hold a special technical meeting to look like you're ahead of the situation. Now you're in a muddle about what happened," said Helima Croft, head of global commodities strategy at RBC. "We have two competing narratives. One, they agreed on a 600,000 barrel cut, and the other that the Russians rejected it."

Croft, speaking from Vienna, said it is not unlike Russia to act "like a runaway bride" and come to the "altar at the last minute." But the lack of a coherent message does raise questions about the group's commitment to its longer term relationship.

International Brent crude futures, initially higher in Thursday trading, lost about 1.5% to just under $55 per barrel. West Texas Intermediate futures were off about 0.4% and were barely holding above $50 a barrel.

"OPEC gets itself into these predicaments where the market forces its hand, and this is one of those times," said John Kilduff, partner with Again Capital. "They're going to have to come up with a significant production cut, even if it's for a limited tim. Someone is going to have to tighten the spigot."

Kilduff said Saudi Arabia is making it clear it will not go alone with the cuts. "The lack of unity calls into question, really the whole scheme now. Even though the Russians agreed the last time around, there were real questions whether they were going to participate." Russia was slow to join OPEC's decision to extend the current cuts in December.

"Is the bloom off the rose?" said Croft, of the Russia-OPEC alliance. "Their [Russia's] compliance has been challenged … If they are going to go against the will of some of the most powerful members of the organization, it raises questions of what is the health of the union."

Russia and Saudi Arabia drove the alliance between the Organization of Petroleum Exporting Countries and non members, like Russia, that was formed in December, 2016. At the time, it united the world's two biggest oil producers and others, in an effort to curb a glut in the world oil market, fueled in part by the growth of U.S. shale oil.

The U.S. has since surpassed both Russia and Saudi Arabia to become the world's largest producer. The U.S. industry continues to grow, pumping as much oil as is economically feasible, while the OPEC+ group has struggled a production cut of 1.8 million barrels a day.

Now with the coronavirus reducing world energy demand, the pressure on OPEC+ is more intense and oil is sliding below price levels that many producers need to support their budgets. At $50, oil prices become challenging even for Russia's industry which has opposed the production cuts from the start.

"At first, it looked like they came up with a recommendation, and it would hold us over to the next meeting, but now there's back and forth on what the Russians agreed to or not agreed to. There's an information vacuum, and someone is going to have to fill it," said Croft.

Russian President Vladimir Putin and Saudi Arabia Crown Prince Mohamed bin Salman are said to have personally guided the alliance. On the ground, the partnership was initially fronted by Novak and former oil minister Khalid al-Falih, until MBS replaced him with his half-brother Prince Abdulaziz bin Salman last September.

"Novak's just playing coy. He's waiting to hear what Putin directs," said John Kilduff, partner with Again Capital. Kilduff said Putin and MBS were reported to have spoken earlier this week.

Oil prices have fallen more than 20% from their early January high, and the sharp drop in demand from China comes as the market was already seeing softness. China has cut off transportation in a number of major cities and grounded all flights. Airlines have cut back flights both to China and Hong Kong.

Earlier Thursday, there were reports that China National Offshore Oil Corp. declared force majeure, which means it won't take delivery of some liquefied natural gas cargoes because the coronavirus limits its ability to move import the fuel.

"There are rumors in the market of all other sorts of force majeures being declared as well," said Kilduff. He said he expects oil demand to temporarily fall by 1 million to 2 million barrels a day.