Surprise: Russia-Saudi Oil Alliance Could Push Prices Down

Subscribe to Bloomberg | Quint
The Daily Newsletter
News & Stock Alerts

(Bloomberg View) -- As the market reaction to the strikes on Syria demonstrated, increased tensions in the Middle East often force oil prices higher. Until some easing of the markets Thursday, crude had been trading at the highest level in more than three years:

Observers understandably worry about production disruptions or the interference in the shipping of crude oil in the Middle East -- nearly a third of the world’s daily waterborne oil shipments pass through the Strait of Hormuz. General unease about heightened political and military tensions in the region can push prices higher even when these two risk factors are not present -- and even when events occur in a place like Syria, which is a bit player in global oil markets.

Yet we may be seeing a radical development affecting how these markets work. The dynamic of growing concerns over Middle Eastern flare-ups and rising prices will remain important. Concerns about a U.S. withdrawal from the Iran deal, for example, are making markets nervous. Yet, the new politics of the region suggest another scenario is also a possibility -- geopolitical risk could actually bring with it the threat of lower prices, not higher ones, at least in the medium and long run. 

The reason for this counterintuitive possibility? One of the most interesting and potentially consequential recent political developments is the budding relationship between Saudi Arabia and Russia. Once openly hostile to one another, the two have established more than a détente in the past year and a half. Leaders from the two countries meet this week in Jeddah, Saudi Arabia, to discuss oil markets and, likely, their relationship.

Plummeting oil prices -- hitting $26 a barrel at the beginning of 2016 -- and shaky fiscal balances were the immediate impetus for Moscow and Riyadh to gingerly put aside their significant differences on issues such as Iran and Syria. It was a rare moment when economics trumped politics in the Middle East.

This rapprochement has underpinned the larger deal between the Organization of Petroleum Exporting Countries and 11 major non-OPEC oil-producing nations over the last 16 months, which has removed approximately 1.9 million barrels of oil a day from global markets. And this despite the fact that in recent years the U.S. has become capable of bringing large quantities of tight oil -- mostly produced by fracking -- on line quickly. 

The success -- and surprising durability -- of this oil deal has helped bolster Russian and Saudi confidence in a more ambitious bilateral relationship. When visiting the U.S. a couple of weeks ago, Saudi Crown Prince Mohammed bin Salman went into the details of the relationship between Russia and OPEC. “We are working to shift from a year-to-year agreement to a 10- to 20-year agreement," he said. "We have agreement on the big picture, but not yet on the detail.”

A long-term supply pact of this nature -- or simply a strategic understanding on oil markets, and perhaps more, between Riyadh and Moscow -- could help restore some of the market power these traditional producers have ceded to U.S. tight-oil producers. It could set oil prices on a different trajectory than would be the case if the market alone were to determine price in the future.

Granted, such ideas are still nascent and the politics behind them fragile. While economics have pushed the unlikely alliance, politics are generally the driver of strategic alignments in the Middle East. There are all sorts of scenarios that could restore that tradition: A conflict between the U.S. and Russia beginning with a missile hit or impulsive tweet on Syria, for instance, could make it more difficult for the Saudis and Russians to focus on economic imperatives. An Iranian-made missile fired by Yemen's Houthis wreaking havoc in Saudi Arabia could also put Iran back front and center in the bilateral relationship between Moscow and Riyadh. 

Either, or both, could lead to the unraveling of the current OPEC/NOPEC deal. Should the current arrangement collapse and lead those 1.9 million barrels of oil to re-enter the market, the price could drop quickly and steeply. Moreover, aspirations for a long-term arrangement between Russia and Saudi Arabia to re-exert control over global oil markets could evaporate and change the course of oil prices for years to come.

There is no question that geopolitics is primed to exert more pressure on energy markets in 2018. With the oil market coming into balance, the healthy oil-supply cushion that helps insulate markets from each geopolitical twist and turn is morphing more into a threadbare mat.

Given the difficulty in substituting another energy source for oil at short notice, even a small hiccup in supply could send prices rapidly upwards in the short term, if not longer. The new reality of U.S. tight oil production -- and its quick supply response to higher prices -- would likely mean these price spikes won’t turn into long-lasting, high plateaus, but they can still be disruptive to the global economy.

So, even with burgeoning American tight oil production, analysts are right to sharpen their geopolitical toolkit and get ready to deploy it. In doing so, however, they need to take into account some very important new realities: that the geopolitics of the Middle East could ultimately put downward pressure on the price of oil, rather than pushing prices up as is conventionally assumed.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Meghan L. O’Sullivan is a Bloomberg columnist and the Jeane Kirkpatrick professor of International Affairs at Harvard University's Kennedy School. She served on the National Security Council from 2004 to 2007, and was deputy national security adviser for Iraq and Afghanistan. She is also a senior fellow at the Council on Foreign Relations, a political-risk adviser and author of "Windfall: How the New Energy Abundance Upends Global Politics and Strengthens America’s Power."

For more columns from Bloomberg View, visit http://www.bloomberg.com/view.

©2018 Bloomberg L.P.

Bloomberg
Stay Updated With View News On BloombergQuint
Subscribe to Bloomberg | Quint
The Daily Newsletter
News & Stock Alerts