Russian oil hit by sanctions and low prices
Oil in Russia is being squeezed at both ends
Russia’s oil industry is under pressure from either side: on one hand, there are western sanctions affecting finance and technology; and on the other, lower oil prices are hitting the budget.
Production is running at a high rate, but given the size of its contribution to the global supply situation, any threat to its existence needs to be taken seriously.
Last year’s sanctions against Russia, first over its involvement in Crimea’s secession from Ukraine and then in the military conflict in southeastern Ukraine, were put in place by the US and then by sanctions from Canada, the EU, Iceland, Norway, Switzerland, Australia, New Zealand, and Japan.
The sanctions banned companies from supplying technology and services that could be used to explore for, or produce, oil and gas from the Arctic, deep sea, shale and other challenging areas. They also limited certain Russian companies’ access to western financial markets.
The EU managed to keep Gazprom off the list of companies that were hit owing to their with links to the president, Vladimir Putin, but Novatek was on the list, affecting its financing for the Yamal LNG project; as was Rosneft. Other companies affected were LUKoil, Surgutneftegas, Novatek, Gazprom and Transneft.
LUKoil had to trim its investment ambitions as the company’s net profit in the third quarter of 2014 was half of what it had been the year before – although this problem is common to companies outside Russia too.
And although LUKoil is on a sanctions list, that is only in relation to a specific and very narrow area of activity. For example, in early August this year it managed to secure up to $1bn of finance for its stake in the Shah Deniz expansion.
The package includes loans from the Asia Development Bank and the European Bank for Reconstruction and Development, which are each providing direct financing of up to $250m each.
Rosneft has applied for rubles 1.5 trillion ($23.3bn) of financial help just “to sustain the liquidity.” Novatek has also approached the government for financial help if its shareholders in Yamal LNG were unable to raise the funds on time – China is however also a major shareholder – and Putin has offered government support.
Since the imposition of sanctions, the market value of Russia’s most powerful oil and gas companies has steadily eroded. Based on trade in over-the-counter shares between 12 September, when both Washington and Brussels announced sanctions against Russia’s petroleum companies, and 16 December last year when the dollar-ruble rate hit its nadir, Gazprom was down 32.1% in dollar terms; LUKoil was down 17.6%; Gazprom Neft was down 26.6%, and Surgutneftegaz was down 16.6%. In rubles, the world’s largest oil pipeline transport company, Transneft, was up 65.8%, but the currency lost 64.8% in that same time frame.
During those three months, the ruble, whose exchange rate against the US dollar is highly dependent upon the world oil price, undermined by the lesser value of oil export sales, fell from 37.78 to the dollar to 69.67 on 16 December, the lowest level for the currency since the Russian currency market opened in 2000.
So the impact of the sanctions was partially offset for Russia by the weaker ruble, as they earned more rubles to spend at home.
Still, the sanctions could not but impact Russia’s oil production. The deputy head of LUKoil Leonid Fedun told UK daily Financial Times in late November 2014 that sanctions could limit oil output in Russia by 7%, from 2015. And as the sanctions apply to offshore and tight-oil developments, they could in the longer term keep about 2m b/d underground.
Too dependent on oil
As hydrocarbons exports account for over two thirds of Russia’s total exports, the country’s GDP is very dependent on the world oil price.
The same may be said about the Russian state budget. Late last year, when Russia reviewed and adopted this year’s budget, the economy ministry and parliament assumed an average oil price of $50/barrel compared with $98/b for 2014.
As Russian oil taxes are linked to world oil prices rather than how profitable a domestic project is, the oil price drop is automatically offset by a proportional decrease in the tax burden, with a limited impact on Russian oil companies who pay lower tax on lower receipts.
Unsurprisingly, Russia’s major oil companies confidently assert that, unlike the Russian state budget, the price could go as low as $30/b and even – if not for long – to $10/b.
Furthermore, they would be happy to produce even more oil just to compensate the lower selling prices, if they had buyers – inside the FSU and outside – and adequate export infrastructure to deliver the extra crude.
Moreover, Russian oil producers can still rely on the government for financial support. It already spends just under $40bn/year in estimated fuel ubsidies.
Russia’s largest oil producer – Rosneft – which accounted for 36% of the country’s total 2014 oil output is still 70% owned by the state, despite the massive privatization of the national oil industry in late 1990s.
State support of the Russian petroleum industry is generous, especially where its state-controlled sector is concerned. And last year about a third of Russia’s oil was actually controlled by the state, based on its ownership stakes in the producers.
This support acts as a bulwark against external pressure on Russian oil companies. Recent history is instructive in this respect. In 2009 the average European spot price of Brent Blend dropped to just above $60/b but almost nothing happened to Russian oil production – in fact it rose a little. Also, spot prices of Brent fell from an average $27.6/b in 1985 to $14.4/b in 1986 and were below $15/b in 1988. Yet Russian oil production was consistently above 550m mt/year all those years.
Allowing for the recent weakening of the ruble, the world oil price in Russian rubles has remained almost the same. Between June 2008 – just before the crash – and June 2015 the average European spot price of Brent Blend, denominated in US dollars, has more than halved – from $132.3/b down to less than $61.5/b, while expressed in rubles it has risen from 3,148/b to 3,369/b. So, if spending is all conducted in rubles, the export sales revenues of Russian oil companies have risen while Brent has fallen.
But as Russian companies have to spend the bulk of their income (including for tax payments) in dollars, this gain is only theoretical.
And last but not least, although producing Russian oil was never cheap, the average technical break-even costs of oil production in Russia are now around $5/b. Even taking into account the long-term oil supply costs of some $40-50/b, as western analysts usually do, there would still be some room for lowering the world oil price without killing off Russia’s oil industry.
Eugene M. Khartukov is professor of economics at Moscow State University for International Relations (MGIMO), CEO of Moscow-based World Energy Analysis & Forecasting Group (Gapmer) and vice-president (for Eurasia) of Petro-Logistics (Geneva).