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Saudi Arabia and Russia – The Unlikely Odd Couple

In an attempt to cope with oil prices, Russia and Saudi Arabia are both giving massive discounts on their oil to gain maximum European market share. However, this in turn is forcing the oil price to stay low. If Saudi Arabia isn’t going to take action this current dynamic could prove costly to Russia’s financial stability.

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‘tis the season to wage war of attrition, tra-la-la-la-la… So much for the spirit of Christmas in the oil industry. 2015’s most unlikely couple Russia and Saudi Arabia will definitely not make it into 2016 if what’s being reported from the recent OPEC meeting is anything to go by. (Catch up – Russia refused to play ball and help it to cut production without losing face – namely by agreeing to cut production too.)

The purported offer on the table in Vienna last week was what we’d expected would happen following the flirtation between the two countries at the Ambrosetti forum of world policy-makers three months ago on Lake Como, when Arkady Dvorkovich head of Russia’s economic and energy strategy said the country was in constant talks with OPEC to bring about a “more rational policy”.

However it rejected the offer then and, teaming up with Iran and Iraq, rejected it again in Vienna. OPEC deny the offer was made but Energy Intelligence is standing by its story.

So what will happen now? It doesn’t bode well. After nothing came of the initial courtship, Russian officials began to accuse Saudi of “dumping” oil in Europe in a bid to smother their supplies. For months Russia had been aggressively discounting oil supplies to Europe but in November it suddenly felt a chill breeze when, for the first time in two decades, Saudi Arabia started to supply Preem AB, Sweden’s largest refining company. Who owns it? A Saudi businessman who until then had been a loyal buyer of Russia oil. A Saudi plan to store crude in Poland’s Gdansk on the Baltic Sea will cater to Eastern European buyers. This fresh competition has forced Russia to further discount their crude export blend – Urals –and it’s being closely watched: OPEC’s November market watch reported that the discount had almost tripled the month before.

It is an epic contest between these two superpowers; both trying to take over as large a market share as possible before Iran’s sanctions are eased to allow it to fully re-enter the market in 2016. They have each pumped at record levels this year, more than 10m bpd, but as a result prices have stayed below $50pb.

The question is, can Russia afford to play this particular game of roulette? The country depends on oil exports which make up half of the revenue the government takes in. The tanking oil market has seen the ruble crash, and inflation rise. Interest rates were used by the Russia central bank to control this: they were raised to 17% at the start of the year but as that negatively impacted on the economy they were dialled back to 11% where they now sit. Yet, confounding expectations, output is steady in a post-Soviet high according to the latest data.

Saudi is not untouched by the low prices. The kingdom is floating unpopular reform ideas such as introducing VAT and cutting energy subsidies. It knows continuing like this will impact on future production, with a deputy oil minister telling reporters that “The scars from a sustained period of low oil prices can’t be easily erased.” But Riyadh is more able than most to cope with the squeeze and having failed to see off US rivals will be keen to secure one confirmed kill. The Independent says Russia’s financial stability would be threatened by an oil price drop to under $30pb. If Saudi doesn’t change course Russia may run out of ideas to cope with falling prices.

Before Friday’s meeting al-Naimi said, “We will listen and then we will decide.” The group reportedly rejected his deal to cut production which means something else is going to happen. Put the heat on won’t you, things just got ice-cold.