MACRO ADVISER: Russia and Saudi Arabia have much to gain from improving relationship

MACRO ADVISER: Russia and Saudi Arabia have much to gain from improving relationship
Russian President Vladimir Putin met with King of Saudi Arabia Salman bin Abdulaziz al-Saud on the sidelines of the G20 summit in 2015. /
By Chris Weafer of Macro-Advisory September 29, 2017

It has been widely reported that Saudi Arabia’s King Salman bin Abdulaziz Al Saud will lead a large delegation of officials and business leaders from the kingdom to Moscow in early October. King Salman does not do courtesy calls so it can be reasonably assumed that his first official visit to the Russian capital is a serious event and we should expect to hear of some substantial investment deals and/or a deepening of the political relationship. Even without the king’s presence, the planned delegation is the biggest ever from the kingdom to Russia and that in itself shows very serious intent.

It is not too many years ago that such a visit would have been difficult, if not impossible. Saudi Arabia has traditionally been a staunch ally of the US and was very much in the western camp during the Cold War. The relationship did not improve in the 1990s as most Gulf media regularly portrayed Russia's then president Boris Yeltsin as the weak leader of a lawless country. Even 12 months ago Riyadh was highly critical of Russia’s involvement in Syria and the relationship looked as frozen as ever. Today that has changed 180 degrees. Both countries now see political and economic advantages from a closer, albeit pragmatic, relationship. This visit is intended to make sure it stays on track.

It is tempting to say that the new-found relationship resulted from Russia's agreement to make a significant contribution to the Saudi led initiative to cut oil supplies coming onto the world market last November. That was certainly a key factor, especially since very few actually expected Russia to make any effort to comply, never mind to fully adhere to its commitment. But the reason for the improving relationship is broader than the oil deal and, therefore, is likely to be longer lasting. Both counties have something of substance to offer each other.

It should also be noted that an important part of the background to this improving relationship is the opportunity created by the weakening in Saudi-US relations since the second Gulf War. US support for Qatar's funding of the Islamic Brotherhood in Egypt and the Al-Jazeera news channel, plus the Iranian nuclear deal agreed by former president Barack Obama, did not go down well in Riyadh. Perhaps what really grates on the Saudis is the fact that having spent billions of dollars to ensure OPEC remained a reliable energy partner with substantial spare capacity, the US totally ignored that and went headlong into shale development, disregarding the damage to the Saudi economy.

But, as stated, the developing relationship is broader than the specific oil deal. Both have much more to gain.

Since Moscow's estrangement from the West in 2014, the Kremlin has been pursuing a policy of diversification. President Vladimir Putin has said that Russia should no longer be too closely aligned, or dependent, on only one relationship. In recent years we have seen an improving relationship with China for sure, but also with other Asian states, including Japan. Political ties with the other Brics states have also improved.

In the Middle East and the Gulf, Russia has a good relationship with Egypt, Israel, Qatar and the United Arab Emirates (UAE). Saudi Arabia was the missing big piece in that jigsaw. It is notable, but hardly surprising, that since the announcement of the Russia-OPEC oil deal late last year there has been no criticism of Russia's role in Syria from any of the Arab states. That is a perfect example of good business — Russia and Saudi both earn close to $2.5bn per month more from exports at $54 oil than they would at $45 — and good politics.

For Riyadh, the engagement is also good economics and good business. Unlike Russia, Saudi Arabia has not allowed its currency to devalue, sticking tightly to the US dollar-peg, and now needs a much higher oil price, approximately $85, to balance its budget than Moscow does. The Russian federal budget needed $115 in 2013 but should balance at closer to $70 this year. The Fiscal Rule aims to cut this to $42 by 2022. The higher oil price also makes it relatively easier for Saudi Arabia to come close to the indicated target valuation of $2 trillion for the Aramco IPO. At sub-$50 per barrel that target would be no more than wishful thinking. On the politics side, the Kremlin provides a back channel to Tehran and that may prove critical if a resolution to the Yemen crisis is to be reached. 

Politics may remain behind closed doors at the Moscow summit but it is widely expected that several mutually beneficial trade and investment deals may be agreed or at least MOUs signed. Russia and Saudi Arabia are already well down that road with a principal agreement between the Russia Direct Investment Fund (RDIF) and the Saudi Arabia Public Investment Fund (PIF) to jointly invest $10bn in projects.

The big projects are likely to be in the energy sector. Saudi Arabia lost its crown as the world's biggest oil exporter to Russia several years ago as the latter has invested heavily in value-added processing in refineries and petrochemicals and is today the world’s biggest refined product exporter. Russia is also the world’s biggest gas exporter and, as the Novatek-Total Yamal project comes on stream, will become one of the world’s biggest liquefied natural gas (LNG) exporters. Saudi is still predominantly a crude oil exporter and needs to diversify, especially as the longer-term future demand for crude oil becomes increasingly uncertain in the age of electric engines.

Speculation is rife about joint ventures under negotiation between the Russian state and private enterprises in petrochemicals and, possibly, an LNG project or even co-investment in some Arctic projects. That would certainly suit the kingdom's declared diversification programme and also provide funding to Russian energy projects that are restrained by US sanctions from easily accessing western capital markets.

Undoubtedly there are many in the Kremlin administration who would be happy to be able to announce a joint venture in gas with Saudi Arabia at a time when the US is accused by the European Commission in Brussels of using sanctions to push its (more expensive) gas to Europe. Saudi involvement in any such project would also make it sanctions proof and would again provide an example of good business and good politics combining.

The Saudi shopping list is also thought to include nuclear power, defence and agriculture. 

Saudi Arabia's neighbour, the UAE, will commission its first nuclear power plant in 2018 and Riyadh is known to be considering its own programme. The reason is that, with one of the fastest growing populations in the world, it is using more and more oil at home and reducing valuable export volumes. An alternative source of power, of which nuclear is just one, would cut the oil export erosion. 

Agriculture is another key area where we may see cooperation. Russia will again be the world's biggest exporter of wheat this year and, despite concerns over quality, the county clearly has the potential to be a much bigger exporter of a whole range of food items. Saudi is one of the world’s biggest importers of food and has made billion-dollar investments in African and Central Asian states to secure supply. Investment in Russia, especially now that the Kremlin has made the modernisation of the agriculture sector a priority under the localisation strategy, would move Saudi’s food supply to a more secure level.

I feel compelled to always close any generally optimistic piece about Russia with a "however". In this case while the evidence of an improving political and investment relations has been building over the past year and the fact the king will lead the delegation to Moscow — again assuming it is not cancelled or downgraded — is itself hugely encouraging, the reality from other high-level engagements is that they have been more in the intention than in the execution. Moscow still needs to create the right opportunities and ease the processes for the good intentions to be converted into either political or investment capital. 


Chris Weafer is a founding partner of Macro-Advisory, which helps investors cut though the noise & focus on underlying trends, real political risks, & opportunities in Russia/CIS, Eurasia Union, & Mongolia. Follow him on @ChrisWeafer.