- - Thursday, January 28, 2016

There was a whiff of desperation in the Russian Energy Minister’s comments Thursday that Saudi Arabia had offered a 5 percent cut in production in a deal with Russia to stem the collapse in crude oil prices. Of course, the Saudis immediately denied the existence of such an offer. Brent crude briefly broke above $35 a barrel in response although now has sold back off, but is still higher on the day. It’s almost as if the Kremlin is attempting to wish something into existence.

“Indeed, these parameters were proposed, to cut production by each country by up to 5 percent,” Alexander Novak said when asked if Saudi Arabia had proposed curbing oil output by 5 percent. “This is a subject for discussions, it’s too early to talk about,” he said, reported Bloomberg News. OPEC delegates responded by saying there were no plans to hold talks to cut production.

Russia is approaching the end of its economic game if the situation continues on the current course. The Kremlin simply cannot meet its obligations, commitments, and agenda with oil at current levels, not forever anyway. There will be a train wreck in its future with oil at $30 for an extended period.

The question therefore is whether or not Moscow can engineer an end to Western sanctions and a ramp up in crude prices in short order. European diplomats and Secretary of State John Kerry have made it clear they would be more than happy to relieve the sanctions pressure on Russia. The Kremlin watched with smug satisfaction as the Obama White House fumbled over themselves in appeasing Iran to get the Iran nuclear agreement last year. They have watched as Iran slapped America in the face over and over again since the deal was signed with missile tests, arresting sailors, et cetera. They probably figure they can get sanctions removed with little effort in the East to give the West a fig leaf in order to do so.

That leaves the price of crude oil which left at current levels could seriously weaken the current Russian government’s grip on power. Hence the current happy talk attempting to drive prices higher. If the Russians can convince the Saudis to reduce production, that will be a major diplomatic win for Moscow. Oil will then most likely have already put in a bottom. However, if the talks and production cuts don’t materialize, then the market could punish crude into the low $20 range. In addition, America shale production is the swing vote in the market now. Fracking production can easily be ramped up much quicker than older drilling techniques as wells that have been shuttered can be turned back on rather quickly. The Saudis know this and that is why they want to force as many American producers into bankruptcy as possible.

Barring some type of agreement on production, the only other option available to the Kremlin will be to engineer some type of military crisis in the Middle East which the market could perceive as threatening the supply of oil from the Gulf. Hence, we see the Russian buildup in Syria as Moscow’s trump card. A card Putin will play if he needs to.

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