Confirmed: Saudi Arabia Offered Russia Oil Alliance and OPEC Membership

Igor Sechin, the powerful head of Rosneft, Russia’s big state oil company, has now confirmed that OPEC – the Saudi dominated oil producers’ cartel – has offered Russia membership.

This comes on the heels of media reports that the Saudis have been pressing the Russians for an “oil alliance” whereby Russia and Saudi Arabia, the world’s two biggest oil producers, would coordinate their production so as to dominate the oil market together.

The Saudi proposal makes complete sense from Saudi Arabia’s point of view.

The Saudi decision last year to maintain oil production at existing levels rather than cut production in response to the oil price fall, was not directed at Russia but at US shale oil producers.

The Saudis know that there is no possibility of the shale oil producers cutting production in cooperation with OPEC. 

If Saudi Arabia and OPEC had cut production last year in order to prop up the oil price the shale oil producers would simply have carried on producing even more oil in order to benefit from the higher price.

Saudi Arabia would have sacrificed its market share and profits simply in order to keep the US shale oil producers in business.

It therefore made total sense for the Saudis last year to maintain production at existing levels in order to price the US shale oil producers out of the oil market.

The Saudis know this will take time – two years at least – but they have calculated, surely rightly, that with their massive financial reserves and their highly liquid banking system they can outlast the heavily indebted US shale oil producers in what is now a price war.

Once the US shale oil producers have been priced out, oil prices will rise.

Some optimistic commentators say that when this happens the US shale oil producers will bounce back and simply start producing again where they left off.

This is a facile idea.  

Shale oil technology is surely here to stay. However the creditors and investors who have poured money into the shale oil industry in recent years – and who stand to lose heavily if the industry falls into crisis because of the low oil price – are going to be very wary of investing in the industry on the same scale again.  

Having had their fingers very badly burnt by the effect of the oil price fall they will be much more careful next time, especially as they now know the Saudis stand ready to flood the market with oil if production once more gets out of hand.

That should be enough to ensure that when the industry recovers it will do so in a more balanced way than what we have seen to date.

A good parallel is with the boom of the late 1990s. Its collapse did not kill off the internet industry. However it did ensure that the internet industry grew thereafter in a more balanced way.

The very latest reports suggest the US shale oil producers are indeed coming under sustained pressure, and that a process of contraction and consolidation is now underway.

Once the challenge from the US shale oil producers is seen off, it makes sense for the Saudis to see whether they can do a deal with the Russians to stabilise the oil price.

Unlike the US shale oil producers the Russians – like the Saudis – produce oil cheaply (Sechin says it costs them just $3 a barrel).  

There is therefore no possibility the Saudis can price the Russians out of the market as they are now doing to the US shale oil producers.

Given that this is so, and given that Saudi Arabia’s interest is to preserve market share and a stable oil price, it is easy to see why the Saudis should approach the Russians to offer an oil alliance.

The idea is that with the US shale oil producers out of the way the Russians would work with the Saudis to support the oil price by agreeing with the Saudis future output levels, whilst dividing the market with them.

In order to seal the alliance and to make it more effective the Saudis have offered the Russians membership of OPEC (Russia at present is only an observer).

It is now clear that this is the proposal the Saudis made to the Russians over the course of the summer, and that it was this offer which was at the heart of the discussions between the Russians and the Saudis that have attracted so much attention.

For the moment the Russians are saying no. 

This could be a negotiating tactic. The reasons the Russians are giving, that their oil industry is not centrally controlled in the way the oil industry in OPEC states is, and that there are technical problems with switching off Siberian wells during winter, do not on the face of it look terribly convincing. Frankly these look like negotiating ploys.

Possibly the real reason is that the Russians are at present expanding aggressively into the Chinese energy market from which they have just ousted the Saudis as the biggest oil supplier. It may be that the Russians are concerned that the Saudis’ offer is simply a device to get them to limit their expansion in the Chinese market.

If that is so, then there may be scope for more negotiations around this issue.  

Possibly the Saudis could agree to grant the Russians primacy in the Chinese market in return for the Russians conceding to the Saudis primacy in the US and Europe.  

Given the importance of the Russian Chinese strategic partnership to Russia, it is a certainty that if any such discussions are underway the Chinese are being consulted and are involved.

Whether a Saudi Russian oil alliance to control the oil market does emerge remains to be seen.

There is however one final point to make about this issue.

Western governments and the Western media have been insistently saying since last year’s Crimean crisis that Russia is “isolated”.

If this episode does anything it shows the utter falsity of this claim.  

So far from Russia being isolated, it is being actively courted by Saudi Arabia, the US’s key Middle East ally, and has just been offered membership of OPEC.

That is not “isolation” however one defines that word. 

On the contrary it shows the central importance of Russia in world affairs and in the operation of the global economy.

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