Nothing like slamming the door on a good deal

A fund manager running a private equity fund out of Luxembourg writes:

Regarding what happened on the ground, one can assume that Saudi Arabia had prepared a plan A and a contingency plan before entering the talks. Plan A was to surprise Russia in Vienna by pressing for a 1.5 bpd cut, including an unplanned prolongment [sic] of the deal until end of 2020. The contingency if that didn’t work was to pump as much oil as possible.

The cut-and-extend proposal was either no surprise at all or a relatively minor one. Early in February, the Saudis were already suggesting a new cut, although much smaller in size. About the same time, the joint technical committee (JTC), an advisory body to the OPEC+, recommended extending the deal throughout 2020. Towards the end of the month, the Saudis asked for more cuts:

The Financial Times last night [Feb. 27 or 28] reported Saudi Arabia is asking OPEC+ members to agree on an additional output cut of 1M bpd with Saudi Arabia taking the bulk of reductions.

As the epidemic continued to spread, the outlook for oil demand kept deteriorating so no wonder that Saudi Arabia soon deepened the desired cut further from 1 mmbpd to 1.5 mmbpd. Back to the Luxembourg-based fund manager now:

Understanding that Russia was neither technically nor contractually able to match the ‘surprise cut’, Saudi Arabia went ahead with its contingency plan and presented Russia as the antagonist in what is today referred to as a “price war”.

And why not – why is it next to impossible to cut 300,000 bpd for a nation producing over 11 mmbpd (including condensates)? The Saudis suggested in March that OPEC cut 1 mmbpd and other OPEC+ members, 0,5 mmbpd, which would have translated (based on output share) into roughly 0,3 mmbpd for Russia. That’s the same as the Russia’s promise to OPEC+ in December 2016, although Russia was then allowed to reduce output gradually, over two or three quarters.

OK, perhaps Russia couldn’t reduce production any further? But judging by the JODI data for the country – self-reported and apparently excluding condensates – its 2017 cut didn’t last for very long. Already in July 2018, Russia was producing more than its October 2016 average, the basis for all OPEC+ cuts. In January 2020 as in the fourth quarter of 2019, its output was 10.6 mmbpd compared with 10.5 mmbpd in October 2016.

In contrast, Saudi Arabia’s output was below the October 2016 benchmark by 0.9 mmbpd in January 2020, by 1 mmbpd in December 2019 and by 0.7 mmbpd in November 2019. (In October 2019, though, only by 0.3 mmbpd after the attack on Khurais and Abqaiq, which had depressed September output to 1.5 mmbpd below the benchmark.) In other words, Russia produced about as much crude in January 2020 as Saudi Arabia had in the benchmark month of October 2016, while the kingdom’s production was down 0.9 mmbpd, or 8%, from that level.

Yet another way of putting it: Russia produced 0.1 mmbpd less than the Saudis in October 2016. In January 2020, Russia produced 0.85 mmbpd more than the kingdom, a relative swing of almost 1 mmbpd. It wasn’t exactly free riding, granted, as Russia actually did make some cuts in 2017, but it must have been a peculiar deal afterwards. “You cut yours and we won’t up ours.” Asked to make a minor sacrifice – minor compared with the kingdom’s – Moscow walked out on the cartel.

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