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Relying on Moscow

Russia holds the Opec agreement's success in its hands

Russia's oil producers, under pressure to deliver the cuts energy minister Alexander Novak pledged in December, will stall for as long as possible before they reduce output.

Russia committed to reduce output by 300,000 barrels a day over the first half of this year. After meeting the country's oil producers later in December, Novak said cuts of 200,000 b/d would be made by the end of the first quarter, leaving the full target to be reached three months after. The cuts are to be distributed proportionally around Russia's producers, but no specific quotas were set.

The market remains sceptical. Most of Russia's producers have, at least, voiced public support for the deal, but haven't been clear on how they intend to do their share of the cutting. Tatneft, Russia's sixth-largest producer, has been an exception-its chief executive Nail Maganov said the firm will reduce output by 20,000 b/d this year through the closure of unproductive wells. Citing energy ministry data, Maganov said the industry would cut 50,000 b/d in January, another 50,000 b/d in February and then 100,000 b/d in both March and April to reach the required reduction.

Evgeniy Tolochek, chief executive of privately held Russneft, says Russia's sixth-largest producer is ready to suspend its marginal wells. "We will fulfill it for sure," he says of the deal. "First and foremost, we will suspend the marginal wells." But other details are scant.

As for the bigger producers that would be expected to do the bulk of the cutting, things are hazy. Vagit Alekperov, president of Russia's second-largest producer, Lukoil, says his firm has not decided how to cut. Lukoil needs cashflow after making massive investments and launching two new greenfields, Filanovskiy and Pyakyakhinskoe, in October.

State-controlled Rosneft ought to be easier to bring in line with the Kremlin's pledge. But Igor Sechin, its chief executive and a staunch ally of President Vladimir Putin, was steadfastly opposed to even freezing production in the weeks before the deal was announced. The timing is particularly bad for Rosneft to make big cuts after it sold a 25% stake in December to Glencore and the Qatar Investment Authority for $11bn.

Political will is meeting corporate reluctance. The public stance of many oil majors is that there should be no cuts without compensation from the government-and, so far, none is being offered. Kremlin-affiliated Surgutneftegas and state-controlled Gazprom Neft have already announced plans to raise output by an average of 1.6% this year.

Lukoil's Filanovskiy field in the Caspian

Russia has some wriggle room too. It stipulated at the outset of talks with Opec that the group must first get its house in order-with a convincing package of cuts-and then Russia would come aboard. During the Opec meeting in Vienna on 30 November, as soon as the ministers had agreed, Saudi oil minister Khalid al-Falih stepped out of the room to call Novak and tell him Opec had delivered its part of the bargain. But any signs that the group's members are cheating could give Russia-which has reneged on such deals with Opec before (see bottom)-a chance to walk away.

In the meantime, for every month that oil trades close to $55 a barrel, Russia earns about $2bn more tax revenue than it did at $45/b. That's a strong reason for Russia to keep the market believing in its commitment to the deal. The cooperation with Saudi Arabia and other core Arab Gulf producers also marks an improvement in Russia's diplomatic relations in the region. That seemed evident in the recent deal to sell part of Rosneft to Qatar's sovereign wealth fund.

"It will be almost impossible for the Kremlin to force or persuade any oil companies to cut, but that is not the point," says Chris Weafer, founding partner of Macro Advisory, a consultancy in Moscow. "Supporting the Saudi-led deal provides strong support for the oil price and federal budget revenues through the winter and early spring, whereas no deal would have risked a price collapse."

Last year Russia set a record for annual oil output, when its production rose 2.5%, even while the Kremlin spent much of the year cosying up to Opec. Whether that momentum continues is one of the biggest questions in the oil market. An early indication seemed to come in the first week of January, when output reportedly fell by 100,000 b/d. The market bought the news, but only until the drop was explained by some brutally cold weather in Western Siberia, where temperatures reached -60° Celsius.

For every month that oil trades close to $55 a barrel, Russia earns about $2bn more tax revenue than it did at $45/b

"The production cut over the past several days probably has more to do with harsh weather conditions in Siberia than with their attempts to do so," says Alex Fak, senior energy analyst at Sberbank CIB in Moscow.

If real cuts are to happen, the sector will need to straighten out which firms will bear the brunt. Novak says Russian producers should trim their output proportionally. But many working in the sector and Russia's financial industry suspect that independently owned firms will bear the brunt.

What Rosneft does will be telling. It controls about half of Russia's oil output and has one of the lowest shares of greenfield developments. So, by Novak's stipulation, its output should fall by 150,000 b/d over the next few months. That looks plausible, even if it isn't voluntary. The firm posted a 1.5% dip in supply in December, shedding 56,000 b/d, because of declines at Yuganskneftegaz and Samotlorneftegas, two of its main brownfields. Whether it lets older assets keep sloughing off more barrels, or redeploys more rigs and works to arrest the fall in the coming months will tell the market quite how seriously the state-controlled firm takes the commitment to cut.

Or will it grow again?

Either way, most analysts remain doubtful that Russia will yield a net drop in supply in 2017. VTB Capital and Macro Consulting both believe output will rise again this year. Wood Mackenzie, another energy consultancy, forecasts growth of 1.3%.

Complicating matters further is that the deal with Opec is only for production, not supply to the market (that is, exports). Even if production flatlines or falls, Russia can keep selling more oil-products or crude-into the market.

In fact, the country's weak economy makes this even more likely. Tatiana Mitrova, of the Energy Research Institute at the Russian Academy of Sciences, showed in Petroleum Economist in June (PE 06/2016) that the close correlation between GDP growth in Russia and domestic fuel demand means that slow economic expansion ends up freeing more oil for export. In short, while Russia's economy remains weak, production is not the real measure of how much oil it exports-the economy, and thus domestic demand, is. Short of a sudden and unexpected burst in Russian GDP growth, domestic demand won't rise and so exports won't fall.

Some creative accounting around any cuts that do happen could be involved too. Christian Boermel, Russia analyst at Wood Mackenzie, expects some companies, such as state-controlled Gazprom Neft, to "trade" volumes in order to increase their own production. If one company cuts, Gazprom Neft might raise by the same amount. It's hard to see how that would bring a net reduction from all producers.

"The impact of the Opec deal on Russian oil production in 2017 will be limited," says Boermel. "We do not expect the cut agreement to be prolonged and, as a result, Russian production will increase again in the second half of the year, reaching new record levels by December."

PE verdict: The market will be pleasantly surprised if Russia delivers half of its pledged cuts

Unfaithful partner

The Kremlin's track record with past Opec deals hardly offers grounds to expect follow through with this one. Russia has said it would cooperate with Opec in the past, only to keep its volumes high or even increase them.

When prices started to drop below $70/b in the second half of 2014, contacts between Russia and Opec resumed. Russia participated in several meetings in Vienna with Opec and non-Opec countries, and Rosneft chief executive Igor Sechin initially committed Russia to a cut.

In one meeting with then-Saudi oil minister Ali al-Naimi, Sechin was overruled by energy minister Alexander Novak and the Russians promptly withdrew from talks. Naimi and his advisors were left confused by the mixed signals. Opec's fateful November 2014 meeting came a few days later and Saudi Arabia opened the taps.

In late 2008, Opec agreed to shore up oil prices by stripping supply from the market. Eventually, the group removed 4.2m b/d, helping markets to climb off the floor. Russia attended the December Opec meeting in Algeria and pledged to join in. Sechin and then-energy minister Sergei Shmatko proposed storing oil, rather than exporting it. But nothing ever came of the idea or Russia's pledge. Over the following months, Russian firms hiked production, profiting from Opec's cuts.

In 2002, Russia delivered on a cut in exports after an agreement with then-prime minister Mikhail Kasyanov. But that deal fell apart quickly. A year after President Vladimir Putin came to power in 2000, Russia also pledged to curb output when oil plummeted-but instead increased exports while Saudi Arabia trimmed.

In 1998 just as then-President Boris Yeltsin sacked his cabinet, Opec agreed to cut output by 2.6m b/d after oil had slumped to $12/b. Russia attended the Opec meeting and consented to a 60,000-b/d cut. The reduction never materialised and output spiked that year.

This article is part of a report series on Opec. Next article: Caspian cuts 

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