Despite Stillborn Deal, Saudi-Russian Petrodiplomacy Could Reshape The Future Of Oil

The Saudi-Iran grudge match still hangs over the oil patch. 

Saudi Arabia and Russia, the world’s two largest oil exporters, finally reached an agreement on Tuesday to raise the price of oil, committing with Qatar and Venezuela to cap future production at January levels. But the petropower accord may never see the light of day, since it is conditional on other major producers accepting similar caps.

Rather than cutting production below current levels, Riyadh and Moscow offered to hold production more or less steady, ignoring – or perhaps because of – the fact that they are each pumping oil at near-record levels. As the head of commodity markets strategy at BNP Paribas aptly pointed out: “by freezing at the high-water mark, you’re entrenching the surplus,” at least until demand expands over time.

Iran may scuttle the deal, since its wants to reclaim market share from its Gulf rival, Saudi Arabia. The Saudis bumped up production several years ago to facilitate tougher sanctions against Tehran’s illicit nuclear program. Now the Iranians want their market share back.

Because Russia is the largest petroleum exporter outside of the OPEC oil cartel, Tuesday’s four-way accord represents one of the most significant OPEC/non-OPEC agreements in years. But Tuesday’s deal still faces significant constraints, including the shallowness of its provisions and the challenge of enforcement, not to mention the make-or-break Iranian angle.

Iraqi and Iranian Production Plans

The biggest likely obstacle to Tuesday’s accord is its conditional nature. Astatement by Russia’s Ministry of Energy made clear that the four countries’ commitment to freeze oil production at last month’s levels is conditional on whether other producers join in as well. And as Frankfurt’s Commerzbank cautioned on Tuesday, “if Iran and Iraq are not part of the agreement, it’s not worth much.”

Saudi Arabia and Qatar can be expected to bring along other major producers in the Gulf Cooperation Council, including OPEC members Kuwait and the United Arab Emirates (which have already signaled tentative support for the accord), as well as Oman, which has previously pledged its backing for coordinated efforts to raise the price of oil.

Yet as the Emirati energy minister cautioned on Wednesday, his country’s buy-in depends on all OPEC members joining up along with Russia. Not only do Iraq and Iran represent OPEC’s largest producers today after the Saudis, they also represent the members with the most significant plans to bump up production in the months and years ahead.

Baghdad produced a record 4.35 million bpd in January, but the Iraqis are also hoping to expand that number to 6 million bpd by the end of the decade. Iran, which produced 2.7 million bpd in December 2015 before sanctions were lifted, has announced plans to pump 5.7 million bpd by 2018. It is difficult to envision any caps being taken seriously if these two growing producers refuse to sign on.

The Iraqis have indicated some flexibility in this regard, announcing that they are open to freezes and “ready to agree with any decision” that addresses the drop in oil prices. On Wednesday, Iraq’s oil ministerreiterated that Iraq supports “any decisions” that would help raise petroleum prices and help balance supply and demand, according to a statement on his ministry’s website.

But the Iranians are another matter entirely. In reaction to the deal in Doha, Iranian Oil Minister Bijan Zanganeh warned that “Iran will not overlook its quota” in seeking to claim his country’s due share of the market. His country’s OPEC representative emphasized that Saudi Arabia, Russia, Qatar, and Venezuela had increased their production by 4 million bpd when Iran was chafing under international sanctions, arguing that it’s now “their responsibility to help restore balance on the market. There is no reason for Iran to do so.”

Now that most sanctions have been lifted, Tehran wants to reclaim its prior share of global oil markets. Saudi Arabia, on the other hand, significantly increased production in 2012 at America’s request so that the market could better withstand nuclear-related oil sanctions against Iran. Now, Riyadh seems to view that extra market share as its due, and refuses to go back to the status quo ante for the benefit of its regional rival, which it rightly views as the largest state sponsor of terror.

Qatar and Venezuela’s oil ministers dashed off to Tehran on Wednesday for several hours of meetings with their Iraqi and Iranian counterparts in hopes of ironing out a broader deal. Qatar holds OPEC’s rotating presidency, and Venezuela’s vulnerable economy is in freefall thanks to over a year of falling oil prices.

But their entreaties came up short. Markets climbed some after the meeting, when Zanganeh offered positive blandishments for the deal. But he also refused to offer any concrete concessions, paralleling his country’s rigid but effective approach to negotiations on the nuclear file. Indeed, an OPEC official from the Gulf concluded that Zanganeh’s vague comments were actually “not very encouraging.”

There is impetus on all sides, to agree to something, anything. I recently came back from meetings in five Gulf countries, and I cannot overemphasize how much concern I encountered, even among some of the richer GCC states, at oil’s recent dip into the $25-35/bbl range. The fear among many of these energy producers is arguably becoming existential, causing decision-makers to wonder just how viable their economic model will be for the long term. What’s new is that oil producers are getting genuinely uncomfortable with their current predicament and are searching for ways to change the market environment.

What about Syria?

Will the stress of dirt cheap oil end up helping or hurting the situation in Syria. The fact that Russia and Saudi Arabia now agree on anything at all is somewhat surprising given that the two countries are on opposite sides of that conflict. Russia’s military intervention there was a game changer for bolstering Syria’s Assad regime. Meanwhile, Saudi Arabia’s rebel clients in Syria are being devastated by Russian airstrikes, most recently around the northern city of Aleppo.

It would be reasonable to wonder whether a consensus between Moscow and Riyadh on oil volumes might presage a broader détente between the two powers. However, barring further evidence it seems more likely that the accord in Doha represents an ongoing conscious effort by Russia and the Arab Gulf monarchies to cordon off the Syria debacle from harming other areas of their relationship.

In the months since Russia’s Syria intervention – and despite being on opposite sides of that conflict – senior officials from Saudi Arabia, the UAE, Kuwait, Bahrain, and Qatar have all flown to Russia for meetings with Putin. In the case of Kuwait, it was the ruler’s first visit to Moscow in roughly a decade if not more.

Outwardly, those visits have seemed surprisingly amicable and in most instances even resulted in new pledges of cooperation on trade or investment. In the cases of Bahrain and Qatar, the meetings also featured an exchange of lavish gifts, such as a falcon, a Turkmen stallion, and a sabre made of Damascus steel. Just this past month, the UAE and Oman also hosted Russian FM Sergei Lavrov in their capitals.

Thus, rather that representing some sort of new alignment on Syria, it seems more probable that Moscow and Riyadh are pursuing a limited tactical understanding where their interests do align, namely trying to bring up the price of oil.

Even if Russia and OPEC can work together, enforcement would be a major challenge to any accord. For example, Russia violated the spirit of at least two past agreements to curb production after oil prices fell in 2001 and in 2008. Qatar has now pledged to monitor compliance, but there is little reason to believe it will succeed this time around.

Broader Implications

Looming in the background of all this petrodiplomacy is U.S. oil production. Russia and Saudi can’t hold on to their market share, while allowing Iraq and Iran to gain market share, unless America’s share drops. And despite 60 oil and gas companies having filed for bankruptcy and double that likely if prices remain low, America’s output remains stubbornly high at 9 million bpd. What’s more, any rise in oil prices would spur renewed drilling in America’s shale fields.

OPEC is arguably weaker than ever before, struggling to reach a common strategy even as the largest outside exporter, Russia, offers to cut a deal with the cartel. Foreign petropowers remain eager to raise the price of oil at the expense of industrialized democracies such as the U.S., where the transport sector remains more than 90% dependent on fossil fuels.

Meanwhile, these petroleum-dependent autocracies are worried about their longterm survival. And they may slowly be coming around to the understanding that any lasting petrodeal between the Saudis, Russia and Iran will need to accept the reality that America’s new share of the global oil market may not be as fragile as they hoped.

David Andrew Weinberg is a Senior Fellow at the Foundation for Defense of Democracies. He holds a Ph.D. in Political Science from the Massachusetts Institute of Technology and previously served as a Professional Staff Member at the House Committee on Foreign Affairs.