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Thu 8 Jun 2017 09:33 AM

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How oil is staining Saudi Arabia's relationships

The kingdom’s determination to raise the price of its most lucrative asset is forcing it to re-evaluate friendships.

How oil is staining Saudi Arabia's relationships
Stronger: Russian President Vladimir Putin, with Saudi Deputy Crown Prince Mohammed, said oil negotiations were improving.

Oil has become such a valuable commodity it is rippling through friends and drawing foes closer together.

In the space of a week, Saudi Arabia said it would cut supply of the lucrative liquid to political ally the US amid its ongoing battle with shale producers, while it tied up with Russia to confirm a nine-month extension of oil production cuts.

It was only a week earlier, on May 20, that Saudi Arabia put on a grand welcome to US President Donald Trump as he symbolically chose the kingdom as the first stop on his first overseas tour since being elected.

But close governmental ties, which President Trump says are now in “a new chapter”, have not been thick enough to cut through Saudi Arabia’s war with US shale producers.

A Saudi energy ministry official said on May 23 that crude exports to the US would fall by 300,000 barrels per day in May and total shipments would remain lower for the foreseeable future.

In March, Reuters reported that senior Saudi energy officials told independent US oil firms in a closed-door meeting that “they should not assume OPEC would extend output curbs to offset rising production from US shale fields”, referring to the Organization of the Petroleum Exporting Countries. In other words, the current truce between oil exporters and US shale producers would be broken if the latter attempted to take advantage of the crude output cuts.

Meanwhile, Saudi Arabia-Russia relations have been on edge during the six-year war in Syria, in which they support opposing sides.

When oil prices were high there was little incentive for Russia and Saudi Arabia – the world’s two biggest oil exporters - to build a relationship. But excess stockpiles of crude, plummeting the value of oil and dramatically cutting state revenues for oil exporters (on top of US-led sanctions against Russia), drove them to a negotiating table in China last year, where they hatched the first agreement to cut oil production and help prop up prices, which have finally crossed the $50 a barrel barrier. The deal was brokered despite non-OPEC Russia long opposing any cooperation in reducing oil output alongside OPEC, of which Saudi Arabia is the de facto leader.

Less than six months later, in late May, they again partnered to agree to extend oil production cuts.

In further signs of warming ties, on May 30, Saudi Arabia’s Deputy Crown Prince Mohammed bin Salman travelled to Moscow, where President Vladimir Putin hailed their growing partnership in oil discussions.

The turn of affairs also suggests that Saudi-led OPEC’s influence in the global oil market is waning. Non-OPEC members, such as Russia, and particularly US shale producers have considerably weakened the cartel’s grip on the global market.

Analysts maintain a degree of scepticism as to whether oil producing countries will fully adhere to the cuts if US shale output is ramped up, snatching more market share. While economics at home now tend to outweigh egotistical desires for market share, the lack of legal implications for oil exporters who do not meet their cut agreement leaves open the door for them to cheat. Those are most likely to be smaller economies suffering the most from lower oil prices.

Jameel Ahmad, vice-president of market research at FXTM, said oil prices would struggle to significantly rise because investors expected US shale producers to offset any efforts by OPEC to rebalance the ongoing oversupply by increasing their inventories.

As Saudi Arabia’s part sale of state energy giant Aramco nears (a 5 percent listing is due in 2018) the kingdom may be willing to befriend whoever it needs to help drive up oil prices, creating a more attractive investment proposition. With a $2 trillion evaluation on the table, choosing allies in the oil market will be increasingly important.

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