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Flatlining in the FSU

The region’s three big producers will have a mixed 2016. Russian output will hold steady, while Kazakhstan and Azerbaijan see small declines

RUSSIA is pumping hard − and will do its level best to keep output at recent highs. Despite the price slump, some analysts even think production will rise this year. We think it will start to fall.

CIB, a unit of Russia’s largest lender Sberbank, predicts output will increase by 130,000 barrels a day, to 10.86m b/d, while RenCap, owned by billionaire Mikhail Prokhorov, expects a rise of 50,000 to 100,000 b/d. Analysts at both UralSib Financial Corporation and Aton Capital appear to be far more cautious, estimating output will be flat or 50,000 b/d higher.

The outlier is consultancy Macro Advisory, which suggests output will dip by 200,000 to 300,000 b/d.

Russia’s oil companies set another post-Soviet record in January even amid plummeting prices and US and EU sanctions that restrict access to international capital markets and technology. Companies have succeeded in accelerating several key greenfield projects while drawing more oil out of ageing fields in West Siberia. Producers pumped the equivalent of 10.88m b/d in January, 1.5% more than a year earlier and 0.5% more than in December.

“I think production will rise this year and in the absence of new refining capacity, so should crude exports,” said Alex Fak, head of oil and gas research at Sberbank CIB. “Most sell-side analysts who were polled think production will rise, so I probably can’t say that my view is contrarian.”

Fak attributes the potential rise in output to the launch or ramp-up of several new projects, including Novatek’s major oilfield Yarudeiskoe, Rosneft’s Messoyakha cluster of fields, Gazprom Neft’s new Novoport and Prirazlomnoye projects and perhaps Rosneft’s Suzunskoye oilfield.

Gazprom Neft, Bashneft and Tatneft led the gains in January, increasing their production 5.6%, 10% and 4%, respectively. Novatek doubled its output thanks to the launch of the highly-anticipated Yarudeiskoe in December, while elsewhere Rosneft and Lukoil continue to show falling production of about 0.9% and 3.1%.

Fak admitted that the situation in Western Siberia is “precarious” because Lukoil is cutting output in the region and Rosneft has so far failed to stem the production decline at its main Yuganskneftegaz subsidiary despite an 80% spike in development drilling there.

But Sberbank and RenCap both believe a potential yield of 70,000 b/d at Novatek’s Yarudeiskoe will more than offset any decline by Rosneft and Lukoil.

The will to freeze

January’s record output figures, which were released amid talks of possible Opec-coordinated cuts that could lift the price of crude, cast doubt on whether the Kremlin wants to – or even can – reduce output. Alexander Novak, Russia’s Energy Minister, suggested in late January that cuts were to be discussed with Saudi Arabia, sending the price of Brent oil rallying to $35 per barrel. But a subsequent energy ministry meeting on oil output could not reach any conclusion due to the absence of Igor Sechin, the head of Russia’s largest oil company Rosneft who is known to steadfastly oppose any cuts.

Russian oil producers would struggle to coordinate an output reduction, hindered by insufficient storage capacity and the need for continuous pumping in the harsh permafrost of many oilfields. “I have been covering the industry since 1997 and I have heard it many times from people on the ground that it could be fatal to turn off some of the wells as you’ll never recover this production again if they freeze and break up,” says Alexei Kokin, senior energy analyst at UralSib Capital.

But production will inevitably slide by the Autumn if prices don’t rebound, he believes. “We are going to see more or less flat production this year assuming the oil price doesn’t really recover or recovers weakly towards $40,” he predicts. “By July and August, there will be a massive revision across the border of capex spending and drilling programmes and there will be less of that starting in Autumn.”

Output so far remains resilient to the lower price thanks to the ruble’s devaluation and tax cushions for the oil majors. But an increase in taxation is looming to help plug a state budget deficit of over $50bn. Finance minister Anton Siluanov said in February he wanted to cut the $15 deduction in the mineral extraction tax formula by about half. Setting the deduction at about R600 ($7.50) would raise a much-needed $12bn for the budget at a price of $30/b.

A deep budget deficit makes a tax hike on the oil sector inevitable, believe many analysts. “The brownfield extraction tax is the largest, broadest and easiest-to-administer tax and upstream-heavy integrated majors like Surgutneftegaz, Rosneft and Tatneft would be hurt the most,” says Fak.

Elsewhere in the former Soviet Union the production outlook is not quite as robust as it is in Russia. Kazakhstan and Azerbaijan, the biggest producers among ex-Soviet countries after Russia, are facing a natural decline in output as ageing fields deplete. Kazakhstan expects to pump 77m tonnes (about 1.55m b/d) of oil in 2016, down more than 3% on the 79.5m tonnes (about 1.59m b/d) produced last year.

The authorities are pinning much of their hopes on the giant offshore Kashagan oilfield, a project more than a decade behind schedule and which is planned to come back on stream at the end of this year.

Azerbaijan’s oil production is likely to decline by around 40,000 b/d to 0.82m b/d this year. Low oil prices have seen BP rein in spending in the country, and it is likely the capital will be diverted to resources which the company judges to have better long-term prospects, such as Azerbaijan’s Shah Deniz II gasfield project.

This article is part of an in-depth series on regional production forecasts. Next article: Middle East: liquid, not solid.

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