Here’s Why Russia Sanctions Are ‘A Game Changer’ For OPEC

Oil retreated from its highest close in three years on Monday morning, and because we have to ascribe causation even when there’s none to be had, we’ll call it “speculation that coalition strikes in Syria will prove to be one-off events.”

WTI

There are a number of interesting undercurrents at play here. For one thing, the EU is thinking about slapping more sanctions on Tehran, according to Spiegel.

“Foreign Ministers meeting Monday in Luxembourg are discussing a proposal by the Political and Security Committee (PSC) to add more Iranian individuals and companies to the existing Iran sanctions list,” the paper reports, adding that “with the expansion, the EU is trying to save the nuclear deal negotiated jointly with the US and Iran.”

 

This goes back to what we discussed late last week in “For Markets, Geopolitics Grabs Center Stage – Who’s Excited?!” You’re encouraged to skim that for the context and details.

Beyond the EU story, Kuwait’s oil minister Bakheet Al-Rashidi told reporters in Kuwait City that OPEC+ will consider extending oil cuts into next year at the June meeting. That’s not really news per se, but if you think about it in the context of the plunging ruble, it gets more interesting.

USDRUB

Late last week, BofAML called the Russia sanctions “a game changer for OPEC” as the pressure on the currency “potentially changes the decision tree path for Russia as we approach the next OPEC meeting on June 22.”

According to the bank, the fixed versus floating exchange rate juxtaposition meant Moscow and Riyadh “had diverging oil market share interests in the long run.” To wit:

Under a floating exchange rate regime, Russia has a strong incentive to increase oil exports to maximize market share. Meanwhile, under a fixed exchange rate regime and a large government budget deficit (Chart 2), Saudi Arabia has a strong incentive to allow oil prices to rise as much as possible. This diverging national interest presented a major hurdle to a renewed cooperation agreement in June.

BKEFiscalMideast

However, the collapse in the ruble now gives Russia one very good reason to deepen its ongoing cooperation with OPEC. Meanwhile, Saudi Arabia has started eyeing $80/bbl as a realistic price target. In previous reports, we have argued that OPEC would likely start tapering its cuts in 1Q19 to prevent a mounting market share loss to US shale (Chart 3).

OPECTargets

We have also incorporated an annual increase of 210 thousand b/d in Russian production into our 2019 oil market balances. Yet renewed US sanctions could potentially trigger an OPEC supply cut deal extension in 2019. Should Russia and OPEC opt to extend the cuts, about 600 thousand b/d of supply would be removed from our 2019 balances (Chart 4). Crucially, US supply growth could struggle to keep up in the short run given the severe transport bottlenecks in the Permian basin.

So that’s interesting and as noted in those excerpts (which are from a much longer note), it comes as the Saudis are pushing for $80/bbl in an effort not only to get the highest valuation possible for Aramco (whose internal finances Bloomberg got a look at last week), but also as MbS seeks to fund a bevy of projects and initiatives, some of which are ironically aimed at diversifying the Kingdom away from a dependence on crude.

In any event, watch the new sanctions on Russia coming Monday for clues as to what comes next.

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