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Washington Watch: Russian Roulette Resolved by the Art of the Deal?

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After COVID-19 caused worldwide oil demand and prices to plummet, the domestic oil industry assumed things could not get much worse. Regrettably, they did. An oil price war between Russia and Saudi Arabia caused prices to drop further. This is the story of those who caused the war (with one name appearing repeatedly) and some who helped end it.

Beginning

The seeds of the oil price war were planted 20 years ago in Venezuela by Hugo Chavez, that country’s president (1999-2013) and ardent critic of the United States. He oversaw a country with one of the world’s largest oil supplies, but his socialist policies failed, leaving the economy in ruins, despite the oil revenue. Russian President Vladimir Putin helped rescue the Chavez regime with financial and military aid. Bearing a grudge against his North American neighbor, Chavez worked with Colombia rebels to flood the Unites States with cocaine. That triggered U.S. economic sanctions intended to induce behavioral changes. Chavez never changed.

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Under Nicolas Maduro, Chavez’s handpicked successor, Venezuelan inflation increased, food supplies decreased, and Russian aid continued. In 2018, Maduro rigged the presidential election in order to win. The opposition balked: the Venezuelan National Assembly called a state of emergency, and the assembly’s president, Juan Guaido, declared himself interim president. Many countries, including the United States, recognized Guido. Maduro cracked down, and conditions in Venezuela worsened. In response, U.S. President Donald Trump issued an executive order stiffening sanctions earlier imposed by President Barack Obama. The order allows the Treasury Department to impose sanctions against all those that do business with Venezuela, except trade for humanitarian supplies. The sanctions are crippling, but the Maduro regime survives with help from Putin.

Provocateur

Rosneft Oil Co. PJSC (Rosneft), Russia’s largest petroleum company, accounting for up to 40 percent of the country’s oil production, is owned in significant part by the Russian state and run by a former KGB agent, Igor Sechen, who is a long-time ally of Putin. Putin has used Rosneft to pester, perturb and provoke the United States. Rosneft invested heavily in oil and natural gas ventures in Venezuela and over the years reportedly loaned billions of dollars to Venezuela’s state-owned oil company, PDVSA, with the loans repaid in crude oil. These cash infusions helped prop up Venezuela’s largest source of revenue.

Putin, seldom confused for a philanthropist, required the Venezuelan oil company to repay its loans. Thus, in 2019, Rosneft affiliates acquired approximately 14 million barrels (mb) of crude from the Venezuelan state-owned oil company. Because those actions violated U.S. sanctions, the Treasury Department (in February 2020) imposed sanctions against Rosneft Trading SA, causing the Venezuelan crude transactions to stop. To skirt the sanctions, Rosneft began to use another affiliate — TNK Trading International SA — to acquire Venezuelan oil. The Treasury Department, in turn, sanctioned TNK Trading. In the face of these U.S. sanctions, Rosneft sold its entire Venezuelan portfolio to another firm owned by the Russian state, which will apparently seek to continue the transactions. So goes the Venezuelan oil sanctions equivalent of “whack a mole.

Face Off

OPEC+ was formed in 2016, when the 14 members of the Organization of Petroleum Exporting Countries (OPEC), led by Saudi Arabia, and 10 other oil-producing countries, led by Russia, agreed to stabilize world oil prices by cutting production. Later, the group extended production cuts through March 2020. In December 2019, OPEC+ met to discuss continued price stabilization efforts involving additional production cuts, with Saudi Arabia and Russia assuming the lion’s share of the cuts.

In January 2020, COVID-19 erupted in China, reducing the Sino-demand for oil, which in turn adversely affected the global economy and reduced further worldwide demand for oil. In February, upset by U.S. sanctions against Rosneft, Putin refused to reduce Russian oil production, thinking that would benefit U.S. shale producers that produced without restraint. Instead, Putin desired to increase production (thereby lowering prices), inflict pain on the U.S. producers and possibly steal market share from Saudi Arabia. The talks broke down, with Saudi Crown Prince Mohammed Bin Salman (MBS) deciding to teach Putin a lesson and entice Russia back to the bargaining table. Saudi Arabia offered steep oil price discounts, triggering a huge drop in worldwide oil prices. Stock markets already wheeling from COVID-19 went even lower. MBS’s gambit failed, Putin demurred, and prices plummeted more.

Statistics

In 2019, the top four oil producers in the world (by barrels and share of world production) were: 1.) United States, 19.51 mb/d, 19 percent; 2.) Saudi Arabia, 11.81 mb/d, 12 percent; 3.) Russia, 11.49 mb/d, 11 percent; and Canada 5.5 mb/d, 5 percent. These four countries account for almost half of the world’s oil production. The price war pitted World No. 2 against World No. 3, and each were well equipped for such a fight. Reportedly, the oil extraction costs for Saudi Aramco are $2.80/barrel and $4/barrel for Rosneft. U.S. shale production costs are much greater, often requiring more than $40/barrel to cover costs. That does not mean, however, that the Saudis were immune from the war’s pain. Forbes reported that in 2016 Saudi Aramco struggled to break even when Brent crude averaged about $45/barrel.

U.S. Response

Against this backdrop a group of U.S. Senators, including North Dakota Senators Kevin Cramer and John Hoeven, wrote a letter to the Kingdom of Saudi Arabia, urging it to stop the price war with Russia. Sen. Cramer also called on President Trump to halt crude imports from Saudi Arabia and Russia and introduced legislation to relocate U.S. armed forces protecting Saudi oil assets to another Middle East country. In return, the Trump appointed Victoria Coates as special energy envoy to Saudi Arabia and tasked her with finding a solution to the price war. Later, the Negotiator-in-Chief telephoned Putin and MBS, “urging” OPEC+ to cut production by at least 10 mb/d. Indeed, Trump reportedly threatened to impose oil tariffs if the two countries failed to forge an agreement. Putin and MBS listened.

The End?

On April 9, OPEC+ tentatively agreed to reduce production by 10 mb/d during May and June 2020, with smaller reductions through April 2022. Putin and MBS agreed to assume half of the OPEC+ production cuts, but sought commensurate production cuts from the United States and Canada. However, price fixing is illegal under U.S. antitrust laws: Competitors cannot agree to raise, lower or stabilize prices. The U.S. government declined to promise government-mandated production cuts. Instead Dan Brouilette, the Secretary of Energy, issued a statement estimating that, by the end of 2020, U.S. production will be reduced between 2 mb/d to 3 mb/d, representing a 10-15 percent cut (due to market forces and financial reasons), which is commensurate with the Saudi and Russian production cuts.

The G20 energy ministers met on April 10 to ratify the agreement; it garnered support from all except Mexico, which agreed to cut its production by only 100,000 b/d or one-fourth of its required cuts. That was not good enough. OPEC+ made the agreement’s effectiveness contingent upon Mexico’s support. At the 11th hour, Trump helped secure the faltering agreement by negotiating a deal with Mexican President Lopez Obrador: the United States would help Mexico meet its production cuts now, and Mexico would repay the United States later. Time will tell whether the agreement will hold, much less whether OPEC+ members will continue to follow their leaders.

Washington Watch is a regular report on the oil and gas pipeline regulatory landscape. Steve Weiler is partner at Dorsey & Whitney LLC in Washington, D.C. Contact him at weiler.steve@dorsey.com.

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