Streetwise Professor

I was somewhat surprised that OPEC came to an agreement. I will be more surprised if they live up to it: that would be not just going against history, but against basic economics. The incentives to cheat are omnipresent (as the Saudi’s ex-Minister of Petroleum of Petroleum Naimi acknowledged in the aftermath of the announcement). Further, what is the enforcement mechanism? Retaliatory output increases/price cuts (i.e., price wars)? Moreover, given that many OPEC nations are facing acute budgetary strains, the present looms and the future looks very, very far away: consequently, getting some additional revenue today at the risk of losing some revenue a year or two from now when a price war breaks out looks pretty attractive.

The breathless TigerBeat-style reporting of the meeting states that Russia’s last-minute intervention rescued the deal. A few things to keep in mind. Russian oil output has surged in the last few months, meaning that its promise to cut 300,000 bbl/day basically puts its output back to where it was in March. This is in fact pretty much true of the OPEC members too: the deal very much as the feel of simply taking two steps back to reverse the two steps forward that major producers took in the past 9 months (and the two steps forward were no doubt driven in large part to improve bargaining positions in anticipation of the November OPEC meeting).

Moreover, the timing of the Russian commitment is rather hazy. Energy Minister Alexander Novak said Russia would cut “gradually.” That can mean almost anything, meaning that the Russians can say “the cuts are coming! Trust us! We said it would be ‘gradual!'” and that there will be no hard evidence to contradict them.

The most amusing part of this to me is that many are interpreting Putin’s personal involvement as proof that the Russians will indeed cut. “If Putin tells Russian oil companies to cut, they’ll ask ‘how deeply’?”

Seriously?

Call me cynical (yeah, I know), but I find this scenario far more plausible: Putin sweet-talked the Saudis and Iranians to overcome their differences to cut output in order to raise prices, all the while planning to sell as much as possible at the (now 10 percent) higher prices. Breezy promises cost nothing, and even if eventually OPEC members wise up to being duped, in the meantime Russia will be able to sell to capacity at these higher prices. Yes, the OPEC members will be less likely to believe him next time, but Putin’s time horizon is also very short, for a variety of reasons. He’s not getting any younger. And more immediately, the Russian recession is dragging into its third year, and budgetary pressures are mounting (especially since he is committed to maintaining a high level of military spending). The Russian Wealth Fund (one of its two sovereign wealth funds) has been declining inexorably: the rainy day fund is almost empty, and the skies still haven’t cleared. And the presidential election looms in 2018. For Putin, the future is now. The future consequences of making and breaking a promise are not of great importance in such circumstances. But more money in the door today is very, very important.

Russia isn’t like other OPEC producers, which have national oil companies that respond to government orders. Although government-controlled Rosneft is the biggest producer in Russia, there are others, and even Rosneft and Gazpromneft have more autonomy than, say, Saudi Aramco. Yes, Putin could, er, persuade them, but a far more effective (and credible) tool would be to adjust taxes (especially export taxes on both crude and fuels) to give Russia’s producers an incentive to cut output (and especially exports, which is what OPEC members really care about). A tax boost would be a very public signal–and reversing it would be too, making it harder to cheat/renege. (Harder, but not impossible. The government could give stealth tax cuts or rebates. This is Russia, after all.) But I have not seen the possibility of a tax rise even be discussed. That makes me all the more skeptical of Putin’s sincerity.

So my belief is that Putin is stepping into the role that Sechin played in 2009, that is, he is being Lucy beckoning Charlie Brown/OPEC with the football. And Charlie Brown is attempting a mighty boot. We know how that works out.

Even if Putin lives up to his pinky-swear to cut output, Russia has cut a much better deal than the Saudis. The promised Russian cut is about 60 percent of the Saudi cut, yet both get the same (roughly 10 percent) higher price, meaning that (roughly speaking) Russian revenues will rise 40 percent more than than Saudi revenues do–assuming that both adhere to the cuts. The disparity will be greater, to the extent that Russia cheats more than the Saudis.

Time will tell, but what I am predicting is that (a) Russia will not cut anything near 300kbbl/d, and (b) cheating by OPEC members will snowball, meaning that next November’s OPEC meeting will likely be another rancorous effort dedicated to repairing a badly tattered deal, rather than a celebration of the anniversary of a successful and enduring bargain.