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Is Russia edging towards the Opec exit?

Russian output remains much higher than the level it agreed to in December 2016 and producers have big expansion plans

All the talk ahead of Opec's June meeting in Vienna is about converting the alliance Opec signed with Russia into an as-yet-undefined long-term pact. Yet the word from corporate Russia is somewhat different: after more than a year of restraint, some of the country's biggest producers are outlining big new upstream growth and investment plans.

Energy Minister Alexander Novak has, at least, added his voice to the plans for indefinite cooperation with Opec—yet, as some observers in Moscow note, the need to rejig things may also be a tacit admission that the current arrangement has run its course. While Russia has no plans to join Opec, Novak said the Kremlin is looking at a range of other formats, including periodic meetings of Opec and non-Opec countries. If so, the new pact might be considerably short of the kind of fellowship sought by Saudi Arabia.

On 3 April, Russia's Energy Ministry reported a monthly increase in oil output for March, which led to Russian compliance with the Opec deal sliding to 93%. Output rose for the first time in three months, according to the official data, hitting 10.97m barrels a day, its highest level in a year. Rosneft and Lukoil both increased output by 0.1%, while Gazprom Neft posted a 0.5% monthly increase. Most of that was attributed to a 14% jump in output at its Prirazlomnoye greenfield and a 6% rise at its Orenburg field.

That total production number left Russian output roughly in line with the quota of 10.98m b/d agreed with Opec in December 2016. But other numbers tell a different story. According to Opec's monthly market report, Russia averaged 11.17m b/d throughout 2017, and output in Q1 2018 was 11.15m b/d, or 170,000 b/d more than it pledged.

Limited restraint

Still, some Russian producers have felt the pinch. Gazprom Neft has been the worst affected by the Opec deal as it was growing at the fastest rate in 2016 and has several large greenfields ready to ramp up. Even if the deal is renewed, chief executive Alexander Dyukov is hoping that the parameters can be changed and that "will lead to an increase in quotas".

Rosneft-controlled Bashneft registered a 0.3% rise in March, due to increased production at its brownfields, while output at the Trebs and Titov greenfields has been stable since August last year. A 0.5% monthly hike at Rosneft's main production unit Yuganskneftegaz lifted its overall output by 0.1%. That growth was offset by a fall in output at Uvat and some brownfields in the Central Region. Lukoil's production was slightly higher in March, with growth in production in the Timano-Pechora and Central regions offset by a decline in output in Western Siberia and Caspian greenfields. Surgutneftegaz and Tatneft were almost flat for the month.

A further freeze in production will most affect Gazprom Neft and Rosneft, the producers actively developing new fields. Vygon Consulting estimates they could add as much as 4m tonnes a year (about 80,000 b/d) and 3m t/y, respectively, if the deal is canned.

While Russian corporateswhich under the country's tax system gain little benefit from price rises above about $60 a barrelmay wish to pump more, the government likes the extra tax and export revenue from a higher price. Novak insists Russia will return to full compliance and blames recent rises on the domestic market and higher gas demand, which bring more liquids production, too.

Not everyone is convinced. "Investors have taken this as a sign that Russia may be starting to back away from its obligations under the deal, so the perceived likelihood of an extension beyond end-2018 has been dropping sharply," says Mikhail Sheybe, equity strategist at Sberbank CIB.

The oil majors are already making plans for life without Opec restrictions. Lukoil is forecasting a 1% annual rise in production for the next few years, while Rosneft plans to lift output by more than 10%, to 250m t/y (or about 5m b/d) by 2022. Tatneft, Russia's fourth-biggest oil producer, is targeting an annual output rise of 2.4% by 2025.

Reconsider the situation

If the deal is extended, Russian oil companies will need to reconsider their plans. Constrained by the Opec agreement and curtailed by a deterioration in downstream profitability, producers have been left with few commercially viable growth opportunities.

Recently published earnings figures confirmed oil majors are at least benefiting from significant tax relief, including from hard-to-recover oil production. Lukoil said recently it may receive mineral-extraction-tax breaks for the Imilorskoe field in West Siberia from 2019.

Higher oil prices added R1.2 trillion ($21bn) to Russia's exchequer last year, though its share of the global market shrank by 0.5%, to 11.2%. At the same time, the US share has increased by 3.2 percentage points to 9.6%.

"The negative consequences for the industry should be taken into account by the state when discussing the fate of the agreement with Opec," says Darya Kozlova, analyst at Vygon Consutling. "Companies need more certainty for making long-term investment decisions."

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