As the anti-terrorism campaign continues to captivate international attention, a confrontation between major oil producing states is building. Falling oil prices are the source of friction. Saudi Arabia is leading an effort by oil producers to cut production and stabilize prices. However, Russia is not complying with the Saudi initiative. The reluctance to embrace production cuts exposes a lack of coordination within the Russian oil industry that could ultimately cause serious economic damage to the country.
The price of oil is now just above $19 per barrel-considerably below the OPEC target range in the mid-$20s. In order to nudge prices back toward that level, OPEC-led by Saudi Arabia-wants to cut production by 1.5 million barrels per day by January, but only if the major non-OPEC producers share the burden by cutting back their production by 500,000 b/d.
Realizing how much they would benefit from an OPEC production cut some of the main non-OPEC producers have already announced that they will go along with production cuts. Mexico, for example, has promised a cut of 100,000 b/d, while Norway has promised to cut up to 200,000 b/d. Russia is the world's second largest oil producer, pumping over 7 million b/d. But Moscow has so far proven reluctant to cooperate in the Saudi initiative.
The Russians certainly seem to know that they are in the spotlight. Despite an appeal made by Saudi Oil Minister Ali Naimi during a visit to Moscow in mid-November, the Russian government initially indicated that it would seek a production cut of just 30,000 b/d. A cut of this size is basically symbolic. After a highly negative reaction from other oil producers about Russia not carrying its share of the burden, Moscow indicated on November 23 that it would cut production by 50,000 b/d by January. Russian government and oil officials are expected to meet in early December to determine oil output targets for the first quarter of 2002.
OPEC officials have indicated the Russian cuts announced so far are insufficient; a cut of 150,000 b/d is what they expect from Russia. The market apparently shares the OPEC view, as the price of London Brent Reference Crude fell by over 4 percent following the Russian November 23 announcement on production cuts. OPEC officials are now worried about the feasibility of the Saudi initiative. OPEC has no formal authority over non-members. If Russia does not cut back production by the desired amount of 150,000 b/d, other oil producers might not cut back either, and the price of oil might continue to plummet.
A Russian-led glut might hurt Russians more acutely than Saudis. Oil exports are the most important source of Russia's hard-currency earnings. In addition, while it only costs Saudi Arabia about $1.50 to produce a barrel of oil, Russian oil production costs are considerably higher-as much as $12 per barrel in some areas. Thus, while a decline in oil prices would hurt Saudi Arabia, that country can still profit from selling oil at far lower prices than prevail now. The same cannot be said for Russia.
Russia, then, would appear to have much to gain by cooperating with Saudi Arabia in cutting back oil production and much to lose by not doing so. Despite this, it seems unlikely that Russia will cut back oil production by an amount that would satisfy Saudi Arabia and other OPEC producers. Some top Russian officials, including presidential economic advisor Andrei Illarionov have described OPEC as a "historically doomed organization."
A major obstacle to cutting production in Russia is the power of the Russian oil conglomerates. In most OPEC member states -- and even those oil producers not in the organization -- the government exercises strong influence over a state oil company. If the government decides to cut back production for budgetary or geopolitical reasons, the state oil company usually complies. In Russia, however, there are half a dozen large oil companies. These oil companies make little effort to coordinate their priorities with the state's. Not only is the Russian government dependent on them for much of its revenue, but Russian politicians are reportedly dependent on them for campaign contributions and other forms of support. It is hardly in the interests of Russian politicians, then, to urge Russian oil companies to cut back on production when this hurts the companies, the government, and the politicians themselves.
Any of these large Russian conglomerates has sufficient influence to veto a large production cut. So while some Russian oil companies might be willing to cut production if all the others do, it appears that it only takes one dissenter to sway the government. According to a November 24 report in The Washington Post, Lukoil was willing to reduce production, but Sibneft said it would stick with plans to boost oil production 20 percent during 2002.
By appeasing these companies, the Russian government may be supporting a domestic cartel at the expense of a global one. Many actors within the Russian oil sector appear to understand that Russia as a whole would be better off if Russia cooperated with OPEC in cutting back production. As a result of the decentralized nature of the Russian oil sector, however, it is not in the interests of any one company to do so-especially when it has absolutely no assurance that the others will. Nor does the Russian government appear able to impose production cutbacks on them all.
Some in Moscow may believe that the Saudis, along with other major producers, are going to cut production even if Russia does not. Thus, they may reason, there is no need for Russia to do so. This, of course, is possible. But this strategy puts Russia in some peril. If the Saudis do not cut production, the price of oil will surely fall-perhaps to below what it costs to produce in several areas of Russia. Russian firms will then have to cut back on their high cost production, while the Saudis can keep up their low cost production indefinitely.
While consumers everywhere, especially in the United States, would certainly benefit in the short term from a prolonged period of reduced oil prices, both the Russian government and Russian oil producers would suffer from it. A fledgling economy like Russia's can scarcely afford to alienate powerful global oil producers in order to placate its domestic ones. Whether the Russians admit it or not, they risk paying a very high price if they do not cooperate with the Saudis in cutting back the overall supply of oil.
Mark N. Katz is a professor of government and politics at George Mason University. He is the author of "Saudi-Russian Relations in the Putin Era," The Middle East Journal, Fall 2001.