BACKGROUND: Saudi Arabia and OPEC have long sought to regulate world oil prices through adhering to production quotas. OPEC has frequently called upon the major non-OPEC producers (which include Russia, Mexico, and Norway) to “do their part” to support oil prices by cutting back on production when OPEC does so. Instead of complying with this request, however, the major non-OPEC producers have maintained or even expanded their production. Riyadh has become particularly concerned about the rapidly expanding production of Russian oil companies in recent years since this has not only eaten into Saudi market share, but has threatened to drive oil prices below the $22-28 range preferred by Saudi Arabia. Partly due to oil market jitters before and during the war in Iraq and the inability so far to restore Iraq’s massive oil production potential, oil prices have been at the high end of this range, or higher, during 2003. But with the continued expansion of Russian production and the likely restoration of Iraqi production in the near future, downward pressure on oil prices appears likely to increase. Saudi Arabia does not want to cut back on oil production while Russia is raising its, since this would amount to a “free ride” for Moscow at Riyadh’s expense. The Saudis, though, apparently came to the Moscow summit hoping they could persuade their Russian counterparts that it was in Moscow’s interests to cut Russian oil production when OPEC did so in order to prevent an oil price collapse. Much to Riyadh’s disappointment, Moscow would not agree. Moscow argues that the Russian government cannot do this because it does not exercise the same kind of control over its oil companies that most OPEC producing countries do. While companies are state-owned or state-controlled in the major OPEC countries, there are several large private oil companies in Russia. But at a time when the Putin administration appears to be tightening its control over the Russian petroleum sector—as was dramatically shown by the arrest of Yukos CEO Mikhail Khodorkovsky, the Saudis are understandably skeptical about this claim. What they do see clearly, though, is that Russian oil firms—with Moscow’s approval—are aggressively seeking to increase their exports to the United States. Further, part of Moscow’s strategy for doing this appears to be through the portrayal of Russian firms as more reliable partners willing to sell at a lower price while Saudi Arabia and OPEC are the unreliable ones who want higher prices. On the other hand, when OPEC (led by Saudi Arabia) does cut production, Riyadh sees that Russian oil firms are willing to take advantage of this by selling at a higher price without bearing the costs associated with sharing in production cuts.

IMPLICATIONS: Less than a month after the Putin-Abdallah summit, Saudi-Russian tensions have re-emerged over oil pricing policy. In late September, OPEC announced that it was trimming output by 900,000 b/d, or 3.5% of production, in order to shore up softening world oil prices. OPEC further announced, though, that it would not undertake any further cuts unless the major non-OPEC producers share in them—even if this leads to a dramatic drop in oil prices. Continued Saudi-Russian disagreement over oil pricing and production levels could have a negative effect on their cooperation in other areas. Moscow has long hoped for large-scale Saudi investment in the Russian oil sector, the participation of Russian companies in the Saudi oil and gas sectors, and the initiation of Russian arms sales to Riyadh. But if Russian oil firms do not agree to cut back their production levels when OPEC does so, the Kingdom is unlikely to oblige Russia in these other areas. The newly formed Saudi-Russian partnership, then, could prove to be a very limited one indeed. While Moscow and Riyadh have not been able to agree on oil pricing policy or on production limitations, one thing that they can agree on—if only tacitly—is that neither welcomes competition in the oil market from Azerbaijan or Kazakhstan. Ironically, while Saudi-Russian cooperation to keep oil prices relatively high would have meant higher prices for oil from these countries too, Saudi-Russian price competition will mean relatively lower prices for them. Further, lower oil prices will make it less profitable for Western oil companies to invest in additional development of Caspian Basin oil resources. Many in the Russian government and oil sector appear to have convinced themselves that while the Saudis might threaten a price war, they would not dare to undertake one. This is because even though Saudi oil production costs of $1-2 per barrel are much lower than Russian ones of $6-12 or more, they see the Saudi government as far more dependent on oil revenue than the Russian government. Because Saudi government expenses are so great, the Russians see them as dependent on keeping oil prices in the mid $20’s. Since the Russian government, by contrast, bases its budget calculations on a price of $18/barrel (with anything over that providing a welcome revenue surplus), Moscow has apparently concluded that it can withstand a lower oil price than the Saudis, and that Riyadh will have to agree to Moscow’s terms for relief.

CONCLUSIONS: This, however, could be a miscalculation. The Saudi government demonstrated its willingness to run up large budget deficits throughout the 1980’s and 1990’s. Further, if Saudi Arabia really wanted to, it could ramp up production so much that the price of oil falls below Russia’s per barrel production cost, but remains above the Kingdom’s own. Nor could Moscow expect much sympathy from the U.S. and other oil-consuming nations—the immediate beneficiaries of an oil price war for as long as it lasted. If Moscow does not come to the realization that Riyadh holds the upper hand in a price war before one starts, it risks acquiring this knowledge in a far more painful manner afterward.

AUTHOR’S BIO: Mark N. Katz is a professor of government and politics at George Mason University.