Oil Realpolitik Has Returned With a Vengeance

[Arab Digest thanks Alastair Newton for this piece. Alastair worked as a professional political analyst in the City of London from 2005 to 2015. Before that he spent 20 years as a career diplomat with the British Diplomatic Service. In 2015, he co-founded and is a director of Alavan Business Advisory Ltd.]

As was widely expected, the  June 30 OPEC+ meeting was a non-event. It reaffirmed the previously agreed July 18, 2021 rate of output increase as modified by the June 2, 2022 decision to bring forward to July and August larger increases which had been scheduled for September.

Expert opinion is that this could prove to be the calm before an imminent storm. As Grant Smith et al wrote for Bloomberg on 3 June:

Only Saudi Arabia and the United Arab Emirates have enough spare capacity to offset a significant portion of the supply gap created by sanctions on Russia. Much of that will remain untapped even after the July and August production increases, setting up a crucial OPEC+ meeting in two months that could determine whether the US and Europe persuade their Gulf allies to break further from Moscow.

However, the wider context, both economic and political, coupled with the challenges involved in the cartel’s internal dynamics, suggest that Riyadh may prefer to stick to the present course for some time yet.

For starters, and as this chart shows, the price of crude has been relatively stable for the past month, with the Brent range bound between US$110 and US$120 per barrel or thereabouts. July’s targeted output increase of 648,000 barrels per day (bpd) is unlikely to change this, not least since the June commitment to “redistribute equally” the 216,000 bpd increase above what was previously agreed across all cartel members means that it will probably amount to only 100,000 bpd or so. This likely suits cartel members just fine as the 2021 agreement continues to serve its intended purpose.

Three Economic Considerations

Furthermore, other economic considerations argue in favor of putting off trying to thrash out a new agreement. Consider three pertinent facts.

First, the proposed EU embargo on Russian oil imports and ban on insurance of tankers carrying Russian oil remains subject to tricky negotiations at the technical level. So it is far from clear how quickly these will come into force and how far-reaching they will be in practice. The impact on EU economies, therefore, is not yet clear. The Economist on June 5 summed up the risks as follows: “Even if the euro area is spared a recession, then, the energy shock will be a drag on growth. The ECB faces an unenviable dilemma. With every increase in inflation on the back of food and energy prices, the European economy is getting weaker.”

Second, in the US, despite a healthy employment rate and high post-pandemic household savings, views — at least from Wall Street — are even more pessimistic and the Federal Reserve looks set to increase the interest rate by at least a further 50 basis points and possibly 75 this month.

Third, as for China, lockdowns are not the only cause of the sharp economic slowdown. Furthermore, the ongoing gradual easing of COVID-related restrictions should not distract from the fact that at the end of June the authorities were still listing one high risk area (in Beijing) and 13 medium-risk ones countrywide. Despite the efforts of the Chinese Communist Party to meet its economic growth targets — not least with an eye to the Party Congress in (probably) November —the challenges involved in avoiding a possible recession are daunting.

At a time when inflation is soaring, these factors present all central bankers, not just the ECB and the Fed, with a dilemma to which there are no easy answers. Consequently, plausible scenarios could yet significantly depress demand for oil and, therefore, the price of crude before year-end as a recent report by Bank of America makes clear.

Added Realpolitik Considerations

Bridging economics and politics is the G7’s move to put a price cap on Russian oil which some experts believe could push the market price of crude up rather than down. While much has been made of the technical difficulties this entails, the politics of winning essential third country agreement are also far from straightforward.

The politics are just as uncertain, with Saudi/US relations front and center. Intense US lobbying was undoubtedly a factor behind the June 2 decision. But even for this modest shift there is a political price for Washington to pay, i.e. US President Joe Biden’s visit to Saudi Arabia this month going back on his pre-election promise to treat the Kingdom as a “pariah”. To try to minimize criticism back home, Mr Biden will look to dress this up as peace-making — admittedly with some justification if the recently extended ceasefire in Yemen holds. In reality, it has more to do with the oil price and the damage which US inflation is inflicting on the already struggling Democratic Party’s prospects in the midterms. Sadly for Mr Biden, former Clinton Administration Energy Secretary Bill Richardson was almost certainly correct that “a president has to try. Unfortunately, there are only bad options. And any alternative options are probably worse than asking the Saudis to increase production.”

As energy expert Helima Croft was quoted as saying in the 3 June edition of the Financial Times, this is “a return to realpolitik” — possibly even to the point where we may yet see agreement on resetting the Joint Comprehensive Plan of Action (JCPOA) and limited US rapprochement with Venezuela.

Riyadh too is indulging in realpolitik. Reports immediately before the June OPEC+ meeting of Russia’s possible expulsion from the group notwithstanding, it clearly makes sense from the Saudis’ perspective to keep OPEC+ together for now at least. Despite last month’s minor deviation, and especially bearing in mind the papering over of the baseline dispute between Riyadh and Abu Dhabi, the agreement struck last year is still the framework within which OPEC+ is working and which may prove to be the glue which is holding the cartel together.

The bottom line? We are very unlikely to have a clearer picture when OPEC+ meets August 3. Thus, both politically and economically, Riyadh certainly had nothing to lose and much to gain by stretching the July 2021 deal out as long as possible.

[Arab Digest first published this article and is a partner of Fair Observer.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

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