Russia to continue dealing with low oil price as no Opec cuts on agenda

By bne IntelliNews June 3, 2015

bne IntelliNews -


Opec members gathering in Vienna for the cartel’s biannual meeting on June 5 are indicating there will be no cuts in production, implying a calmer meeting to the last one in November that featured calls from some members for Saudi Arabia and its Gulf allies to tighten supply to raise prices. 

Opec is sticking to its November decision to maintain its collective production ceiling of 30mn barrels a day (b/d) in spite of a perceived glut of oil on the global markets. Opec output accounts for just under a third of total global production, according to the International Energy Agency (IEA). In a draft long-term strategy paper obtained by Reuters, Opec said shale oil is proving a much tougher enemy to beat and the traditional oil producers of the cartel need to keep oil prices relatively low for another two years and perhaps even longer if they are to regain market share from the largely US producers of unconventional oil.

That's bad news for Russia, which relies heavily on oil revenues to balance its budget. Oil prices fell to below $50 a barrel in December from an average of over $100 in 2014, dragging the value of the ruble down with it. Oil prices have recovered somewhat in the first quarter of this year, trading in a band of $65-70, alleviating some of the pain. But analysts say there is now a global oversupply of oil which is putting a cap on prices, and few expect them to rise much any time soon. Indeed, according to some recent analysis, oil prices could fall again later this year.

Russia is not helping the situation. Not only has it not cut its own production to support prices, but it actually increased output to close to post-Soviet record levels. Russian production of oil and gas condensate climbed 1.6% from a year earlier in May to 10.708mn b/d, close to January’s post-Soviet record of 10.713mn b/d, according Russia's Energy Ministry’s CDU-TEK unit. That makes Russia the single biggest oil producer in the world today and it is actively contributing to the global oil glut in exchange for the badly needed hard currency it earns.

Why, if the Saudis and other Opec members say any output reduction from them would have to be done in concert with non-Opec producers, particularly Russia, is Moscow proving so adverse to agreeing any such cut now or even later in the year?

The Kremlin has admitted it is involved in "unprecedentedly active" consultations with Opec – most famously the Venezuela-orchestrated gathering ahead of the Opec meeting in November that included Igor Sechin, head of Russia’s biggest producer Rosneft, and Alexander Novak, Russian energy minister, as well as the oil ministers of Mexico and Saudi Arabia. However, Russia won’t agree production cuts alongside Opec for several reasons.

Firstly, the Russian economy appears to be stabilising and the recession is widely predicted to be not as deep as some had feared at the beginning of the year.

Secondly, to get its economy growing in the face of continuing Western sanctions, the Russian government believes the best way is to sell as much oil as it can, relying on market forces to squeeze high-cost projects both at home and abroad, such as US shale oil, rather than artificially raise the price by selling less.

Thirdly, Russia’s oil-dependent economy is also cushioned from the falling oil price because its currency depreciates in line with it. A rule of thumb is that each $10/b movement of the oil price down shaves RUB2 off the dollar exchange rate. In this way, the hard currency the government receives from selling oil on the international markets is worth that much more to the ruble-denominated budget.

In any case, technically, Moscow insists it couldn’t cut production even if it wanted to. "Russia consistently argues that because of the technical nature of its wells it cannot simply turn up or down production as can be done in all of the Opec countries because of their geology," says Chris Weafer of Macro Advisory. Russia also argues that, unlike in Opec countries where all have 100% ownership over national oil companies, it does not have exclusive ownership of the oil producers. Rather, they are all stock market-listed and have minority shareholders, so to force a cut on any company would be deemed an abusive action against minority shareholders.

Finally, there is the difficulty of the Saudis and Russians working together. There is little trust or love lost between the two sides. This is a legacy, in part, of events in 2008 when Russia reneged on a promise to hold back output in coordination with Opec, and increased it instead, grabbing market share off the back of the group’s actions. "The only way an agreement like that could work would be if there were really potent enforcement mechanisms to monitor and force compliance, but I can’t see a realistic way that the Saudis and the Russians could develop those. In the past Russia has signalled its public approval of Opec production cuts while actually increasing its own level of production," says Mark Adomanis, a US-based Russian commentator.

Sure of shale

Opec is widely believed to have engineered a collapse in the oil price as an attack on US shale oil producers, which have increased their production dramatically in recent years. Opec publishes its long-term strategy reports every five years and its 2010 report did not even mention shale oil as a serious competitor, highlighting the dramatic change the oil markets have undergone in the past few years.

Still, as shale oil is technically difficult to extract, these wells are only profitable at some point above an average of $62 per barrel, according to a recent report from independent oil and gas consultancy Rystad Energy, although the actual breakeven price depends on the deposit. The problem is that even if shale is more expensive to extract, these higher costs are partly mitigated by continuously growing demand, driven by the economic development of emerging markets.

While global oil production has not fallen, the number of new oil wells being drilled in the last six months has. Given that US shale production is largely financed by the issue of junk bonds on the US capital markets, analysts believe that Opec would have to keep prices low for at least a year in order to bankrupt any of the shale producers, or at least make it impossible for them to refinance their debt.

However, the success of Opec’s apparent plan remains in doubt. Rystad Energy suggests that shale oil production will continue to climb as producers respond to lower prices by cutting costs. The consultancy predicts that while there was a dip in unconventional oil production in the first quarter of this year, output of shale oil will continue to rise from 4mn b/d in 2005 when the industry got going, to 15mn b/d by the end of 2017 – half as much again as Russia currently produces.

Having said that, the biggest, fastest-growing oil producer in the US plans to keep its output almost unchanged this year, halting its breakneck pace of growth and delivering another signal that shale producers are ready to cut when needed. EOG Resources, which has boosted its oil production by almost 50% annually for the past five years, is slashing spending 40% and will drill half the wells it did in 2014, Bloomberg reportsThe company follows other leading US shale producers that have slashed expansion plans; the number of US oil rigs drilling in American basins has fallen for 24 straight weeks, plunging by 59% from their peak last October.

Still, overall US production of oil is expected to continue to climb this year despite the lower prices and could surprise on the upside. A report released last month by the US Energy Information Administration said that US oil production surged to 9.56mn b/d, its highest level in 44 years. And the EIA is predicting US production will continue to expand by 7.8% in 2015.

The global glut in oil has been exacerbated by the lower-than-expected worldwide demand for oil, which will increase by only 800,000 b/d, according to recent research from the International Monetary Fund (IMF). The faster-than-expected recovery of Libyan oil production in September and unaffected Iraq production, despite unrest, have also pushed supplies up.

The bottom line is that if Opec’s plan is to reduce US shale production, it will only be partially successful; countries like Russia will simply continue to produce oil at lower prices as it continues to make them a profit. By 2019, Opec crude supply at 28.7mn b/d will still be lower than in 2014, the Opec long-term strategy report said, and demand for its oil will start rising only after 2018-19, reaching almost 40mn b/d by 2040. Taking all this into consideration, the IMF researchers predict that prices will rise slowly in the coming years to reach $73 per barrel by 2019. 

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