How Would Russia’s Departure From The OPEC Deal Impact Oil Prices?

The year 2018 appears to be a turnaround year for commodity prices. Since the Organization of Petroleum Exporting Countries (OPEC), along with Non-OPEC members such as Russia, decided to extend the production cuts of 1.8 million barrels of oil per day (bpd) in November 2017, Brent crude oil prices have gone up almost 10% and are currently trading close to $70 per barrel. While the rising US production due to the improving oil prices continues to be a key concern for oil investors, the OPEC and its allies continue to believe that the situation is within their control.

That said, Russia, a key Non-OPEC participant of the oil supply cuts, is a crucial driver of oil prices. The country is at present restricting its oil output by 300,000 bpd, almost 50% of the total output reduction committed by the Non-OPEC members. The nation had agreed to extend the production cuts until the end of 2018 on the condition that it would review the improvement in oil prices in June 2018 and decide its future course accordingly. In a case where the oil markets responded as anticipated by the cartel and oil prices surged, the country would have an option to pull back from the deal.

Interestingly, the sudden surge in oil prices in the last two months has made the OPEC and Non-OPEC nations anxious about the effectiveness of their strategy to stabilize oil prices. Consequently, the participants of the OEPC deal meet in Muscat, Oman on 21st January 2018 to discuss their strategy. While the cartel ruled out any change in the existing production cuts in this meeting, the members are likely to continue cooperating with each other even after the current deal expires in 2018. That said, the exact nature of this cooperation has not been  decided yet and there continues to be a possibility that Russia might want to pull out from the deal at the OPEC’s June meeting.

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Our Take

Given that oil prices have already reached the $70-per-barrel mark within a few weeks of the extension, we believe that there is a strong possibility that Russia, after discussing the implications with the OPEC nations, may decide to discontinue the output restrictions in a future meeting, perhaps in June 2018. This is because, according to some market experts, Russia’s fiscal deficit due to the depressed oil prices is much lower than that of the OPEC nations. Since the oil prices have recovered sharply from close to $26 per barrel in early 2016 to almost $70 per barrel currently, Russia is expected to make good its deficit in the coming months and might want to leverage the increased oil prices in the remaining half of the year.

In the chart above, we depict our base case (grey bars), where we have assumed a slower growth in Russia’s output in 2018 and beyond. However, in order to visualize the impact of this unforeseen event, i.e. Russia pulling out of the OPEC deal, on the Brent oil prices, we have created a scenario (blue bars), wherein we have gradually increased Russia oil output for the second half of 2018 and beyond. Using our interactive platform, we figure that while Russia’s departure from the deal may not have a significant impact on the Brent oil prices in the short-term, it is expected to result in a drop of almost $10 per barrel by 2024. As per our base case estimates, Brent prices would reach $90 per barrel by 2024, while oil price recovery would be limited to $80 per barrel in 2024, if Russia moves out of the deal before the end of this year.

You can also create our own scenarios and visualize their impact on oil prices using our interactive platform.

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