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Saudi Arabia and Russia oil alliance: Desert kingdom requires Russian co-operation to solve economic problems

Petrostates have historically been wasteful in regard to spending the wealth generated by large-scale fossil fuel extraction. The desert kingdom of Saudi Arabia is no different, spending vast sums on subsidizing fuel and extensive social programs; most of the workforce is employed by the state, funded by oil. Now the country is undergoing significant reform to correct economic imbalances and diversify the economy.

The Aramco IPO is driving Saudi Arabian policy, which in turn is likely to be directing the nature of OPEC policy. Oil futures for March 2019 are currently just above $60 per barrel, and futures for 2020 are a few dollars lower, causing a degree of concern in Riyadh and inciting action to boost prices by keeping production limits in place for a while longer.

The pumping of vast sums of money into state coffers will help to bring about a diversified economy that is beginning to open to tourism, increased economic participation by ordinary people and even mass entertainment. Plans to dramatically improve efficiency of energy use, allowing more oil exports without increasing production, cannot be put into action without significant investment.

Russia has been placed at an advantage in the thawing of relations with Saudi Arabia by requiring a lower oil price to sustain the nation’s finances, meaning the incentive to raise prices is not as strong or a serious immediate concern. Obviously potential access to the IPO is of keen interest to the Russian state – enough, at least, for calls not to extend the previously agreed reduction in oil extraction to be heeded.

Saudi Arabia would appear to have much more to lose in the current economic climate than Russia does due to domestic conditions which have been exacerbated by the threat posed by producers of shale gas in the United States. Events point towards thriving mutual benefits of further co-operation, but the direction of travel regarding necessity means Russia stands to benefit the most.

Worse still, the United States, according to The International Energy Agency (IEA), could overtake both Russia and Saudi Arabia to become the largest oil producer. Such an eventuality means Saudi Arabia is now under greater pressure to go ahead with the Aramco IPO – an action the country does not want to take until futures prices rise to a level at which the required valuation can be met.

Other developments in the United States and beyond have ramped up the pressure on Saudi Arabia to find international help to ramp up the oil price in preparation for the Aramco IPO. Efficiencies have been found in oil rig design through much improved standardization of parts and an end of the ‘gold-plated’ designs of yester year. Lower breakeven prices mean leading oil companies can make profits even when production is high. For Saudi Arabia this has meant relying on Russian help to force the oil price upwards, enabling the state to fund solutions to domestic problems.