Oil Prices: An Action Strategy Is Needed

19 march 2015

How to Make the Market Predictable

Andrei Baklanov is Head of the International Affairs Department of the Federation Council of the Russian Federal Assembly; Ambassador Extraordinary and Plenipotentiary; Deputy Chairman of the Board of the Association of Russian Diplomats.

Resume: We need a substantial strategy of pricing policy and implementation mechanisms to avoid emotional shocks every time oil prices drop. The fuel market should be more controllable, balanced, and fair, as Russia’s national interests demand.

Russian policymakers and economists are concerned about the possible dire consequences of the sharp drop in oil prices. I would like to share some little-known facts showing that the price component has always been the weakest point in Russian energy policy, and propose some measures that may help overcome this trend, which is dangerous to Russian interests.

In 2000-2005, as Russian ambassador to Saudi Arabia, the world’s largest oil producer, I represented my country at meetings of the Secretariat of the International Energy Forum in Riyadh and had permanent contacts with Saudi and other foreign specialists to discuss energy problems.

During those discussions I was often asked to explain why Russia, a country highly regarded globally for its bold, large-scale energy projects and record fast development of large oilfields in remote areas, was so inconsistent and inert in devising measures to influence pricing on the energy market. I believe the question was warranted by solid reasons, which, regrettably, are still valid today.

I will refer to my own experience. In the late 1960s I was involved in the work of an economic group at the Soviet Embassy in Egypt, a key Arab state in the Middle East. In this capacity I was probably the first Russian official tasked with looking into the intricacies of the complex game played by OPEC and its recently established (1968) Arab counterpart – the Organization of Arab Petroleum Exporting Countries (OAPEC).

Acting primarily in the interests of oil producers, at that time those countries acknowledged the need for compromise and due account for the opinions of other major players on the energy market. Those countries sent us signals that they were ready for closer contacts with us in energy pricing.

Simultaneously, those countries made it clear that they wished we “played by the rules.” In fact, oil producers did not like Russia’s approach to supplying oil to Warsaw Pact countries at nearly half the world price. The Arabs also drew our attention to the fact that universally acknowledged market mechanisms did not regulate a considerable segment of the global energy trade. Thus prices could be negotiated and even reduced in bypass of objective criteria.

I agreed with those Russian economists who called for establishing a permanent interaction channel with OPEC and OAPEC, and pursuing practical and substantial coordination of our policy. For a long time, however, the government officials proudly declined these proposals, reasoning that we should not bind ourselves to “group commitments.” At the same time, they did acknowledge the need to probe OPEC’s plans.

The Soviet Union held to this ambiguous and inconsistent position for years. Indeed, there seemed to be no grounds for revising it. At that time oil prices did not cause any concern and the outbreak of hostilities in the Middle East in 1973 only strengthened the belief that “everything was well on track.” Nobody wanted to hear about the increasing volatility of oil prices.

Unexpectedly for a majority of politicians and economists, the situation that developed on the hydrocarbons market in 1983 vindicated the arguments in favor of devising measures to protect the market from price fluctuations. In several months in 1983, oil prices plummeted by one-third from the 1980 level. The measures OPEC implemented were insufficient. The organization needed accords with other large oil producers, including the Soviet Union.

In these conditions, OPEC representatives stepped up “probing” contacts with the Soviet Union in late 1983 to see if it was possible to coordinate the pricing policy in the interests of oil producers. I was directly involved in those contacts.

I was on temporary duty at the Soviet Embassy in Great Britain at the time. At the instruction of the Embassy administration and Ambassador Victor Popov, I joined the ongoing consultations. Essentially, the proposals forwarded to the Soviet Union were simple: OPEC wanted full-fledged negotiations over energy market problems with the aim of making substantial, long-term decisions.

All proposals were reported to the Soviet government, yet again the response was in no way interested nor justified. The alarming signals from oil prices were ignored. No decisions followed in response to probing from Saudi Arabia in 1982-1984 regarding the restoration of diplomatic, trade, and economic ties and transition to a coordinated oil policy.

The tragic consequences of this short-sighted policy appeared several years later, as world oil prices plummeted to around $27 per barrel in 1985, and still lower to $14-15 in 1988, which admittedly was one of the reasons behind the collapse of the Soviet Union.

A belated decision was taken to launch closer consultative ties with OPEC, but our country made almost no attempts to secure a more predictable situation on the energy market. In 2000, Saudi Arabia suggested setting up a new organization – the International Energy Forum (IEF). The initiative was based on the quite rational principle of representation in the IEF of all countries interested in a stable market, both major producers and large consumers, as well as energy transit states. Our country’s support for the bid was largely declarative though.

Norway’s representative Arne Walther was the first IEF Secretary General. His country boasted the most rational system of control over the energy sector and, as many experts acknowledge, was consistent in taking measures to ensure predictability of the oil market. I used to meet Walther regularly and attend functions at IEF headquarters. My general impression was that the organization had great potential, although it was poorly used.

At the first stage of its operation, the IEF made a sizeable contribution to the development of an energy security concept. During a bilateral meeting in August 2005, Walther voiced the idea that Russia should make the issue a priority during its upcoming G8 presidency. Additionally, this question was raised at a subsequent meeting with Saudi Arabia’s King Abdullah. It should be noted that Russian-Saudi relations were on the rise at the time, and high-level consultations over various aspects of energy policy were envisioned in one of the agreements signed during King Abdullah’s historic visit to Moscow in September 2003 and his talks with Russian President Vladimir Putin.

The Russian government reacted positively to the proposals and “energy security” became one of the three key themes of Russia’s G8 presidency. Regrettably, no further action came out of that international cooperation. In recent years, a worsening political situation has frustrated practical results in forming a new balanced and predictable energy market.

Overall, a retrospective view of the history of Russian pricing policy is not inspiring. Russia lost many opportunities and the consequences of the feeble and inconsistent approach towards this sector were sometimes dramatic. However, the situation has improved recently, although sweeping stabilization proposals have not yet become systemic.

WHAT COULD BE SUGGESTED?

First, we should give an honest answer about what the current oil price is and consider the specifics of the energy market in general. If we do not, then we will face unpleasant surprises comparable to the 2008 crisis. In my opinion, the current energy market is a product of unhealthy and inflated market indicators. It was only in 2000-2003 that the price corridor was more or less justified (at $22-28 per barrel). Later prices surged to $60, then to above $100 per barrel. Needless to say there were no reasons for a three- to four-fold increase in prices in the past decade.

With that in mind, the “speculative” component in the oil price currently reaches a record 30 to 50 percent. Who is the interested party? On the surface the beneficiaries are oil producing countries. But it is not that simple. It seems the years when the oil market was governed by Western monopolies (the so-called “Seven Sisters” – five American and two European companies) have taken their toll. The system still exists in which super profits are de-facto shared between leading oil producing countries and Western states. Sharing is effected through the acquisition of U.S. securities or those of other countries. Therefore, the purported “national heritage foundations” in Arab countries are sometimes just a cover-up for such schemes.

I believe this system is what Saudi oil and gas leaders and experts had in mind when they claimed that the bulk of super profits was appropriated by “profiteers” from the U.S. and other Western states that actually give the green light to unjustified oil price hikes or decreases – depending on which is more advantageous.

Today’s oil price corridor should be within $52-58 dollars per barrel. Let us add ten more dollars to balance the expenditure on the development of new oilfields in remote areas in the Far North and offshore. In any case the final price would not exceed $68 per barrel.

Second, it is important to advance towards creating oil reserves, perhaps through a large international stabilization reserve fund of hydrocarbons.

Third, Russia should change its indifferent attitude towards the International Energy Forum, which works out recommendations on how to synchronize the interests of different countries and ensure the stable and predictable development of the energy market.

At the same time, the IEF should receive help in overcoming inertia in its operation and move from participation in events held by various national and international agencies to independent actions in the interests of creating a new global mechanism for energy pricing. Oil prices should be based on a rationale. Exorbitant prices are dangerous for the future of oil producing countries because they stimulate the search for alternative energy sources.

Fourth, it is necessary to develop a common approach to setting an optimal and conciliatory “oil price corridor.” Additionally, countries should work towards a new type of energy market that is predictable, reliable, and stable.

Thus we have to take dynamic action. Work according to this guideline is just beginning and a lot of time has been lost. Let me again refer to my own experience. On returning from my secondment to Saudi Arabia, I agreed to the publication of my forecast in Russian Oil magazine (No. 6/2007, “The Bottleneck in Global Economy”). In it, I offered an analysis of the energy market and some proposals that include the above-mentioned positive features. The article stirred some interest, but few of the proposed measures were implemented.

It is time we start acting at last. We need a substantial strategy of pricing policy and implementation mechanisms to avoid emotional shocks every time oil prices drop. The fuel market should be more controllable, balanced, and fair, as Russia’s national interests demand. This is necessary for Russia to play a more significant role in the modern world and global economy.

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