Russia back to growth, of a kind
Petroleum supplies to the international market should rise in 2018
We expect further production growth from Russia's oil sector in 2018.
Despite the oil price, which remains relatively low, technological and financial sanctions against Russia, which were strengthened in 2017, and the deal with Opec to cut production, which curbed Russian supply last year, 2018 will bring more oil. It will be the resumption of the trend. Between 2012 and 2016, Russian oil output rose by 6%, from 10.4m barrels a day to 11m b/d. And according to our estimates, in 2018 the number should increase to around 11.4m b/d.
It's not all straightforward, because the producing profile has been changing over recent years. Oil production in older fields, the brownfields, fell by 5% (or 400,000 b/d) in 2012-16. The share of output from Western Siberia, Russia's main oil-producing region, was also noticeably down, from 62% to 56%.
Russia's brownfields have entered a stage of unmistakably declining output. Even an increase in drilling in these mature fields—an increase of 22% in the past five years—hasn't compensated for the decline (and tertiary recovery methods are hardly used in Russia). Just to maintain current output levels in brownfields, a whole complex of measures is needed. These include enhanced recovery of older oil reserves at the active fields, as well as hydraulic fracturing. That's where the sanctions have an impact: they crimp Russian producers' access to the technology needed for these kinds of techniques. And then there's the pure economics. The higher costs make these projects less profitable, especially when the peculiarities of Russian taxation are added in. Inevitably, brownfield development isn't so attractive to companies at the moment.
5%—Rise in Russian oil exports in 2018
Instead, companies are going for the newer, more prospective prospects—the greenfields. Usually these are remote and technically complex oilfields. Nonetheless, the majority offer significant taxation advantages. So, in recent years, the entire growth in production came through the commissioning of new fields. In the past five years, production at the new oilfields was up by 77% (or 1m b/d). This won't change in 2018, when we expect greenfield output to continue rising and yield growth of 400,000 b/d. Production will also come from some of the new projects. Between them, Russkoe, Yurubcheno-Takhomskoe and Kuyumbinskoe will produce about 100,000 b/d in 2018, with further growth in the years after. All this growth in the greenfields will easily compensate for the loss of about 160,000 b/d from the declining brownfields.
But what about the deal with Opec to restrain supply?
For sure, the agreement could—assuming it's extended beyond the end of Q1 2018, or the cuts were deepened—have a significant impact on the commissioning of new projects and on the intensity of their development. Gazprom Neft, for example, was forced to reduce production at its new Novoportovskoe field in 2018 to keep its commitment to the pact.
For now, it looks likely that Opec will extend and that Russia will sign up again too. After all, the goal of the agreement was to rebalance global supply and demand—and it was the cuts in production that allowed a fragile balance to emerge between traditional and shale oil producers, in turn bringing the oil price into a range of $50-60 a barrel. That price seems acceptable to all. At the beginning of October, President Putin stated clearly that "based on the realities in March 2018, we will make our decision, but I do not rule out that we may extend" the agreement. In fact, it remains possible that restraint in both production and exports could become a long-term reality for all the parties of the Opec deal, including Russia. Quitting the deal before the excess supply is absorbed might lead to a significant price fall, which isn't in the interests of producers.
As for the sanctions, they are extremely unlikely to have an impact on the projects being commissioned in the next two-to-three years. Most of the investment in production has already been made, and contracts for the supply of the necessary equipment have also been signed. The sanctions don't extend to existing agreements. And just as significantly, the greenfield projects planned for the next few years don't actually need the deployment of new technologies that are subject to sanctions—unlike deep-water Arctic developments or shale oil.
In any case, what's most interesting—for the wider international market, anyway—about Russian oil output isn't the production itself but the volume of exports, both of crude oil and petroleum products. Here, some interesting developments should be noted; the main one being that Russia has remained an export powerhouse, despite the curbs on wellhead supply. Thus, in the period from January to July 2017—that is, after producers started cutting in line with the Opec pact—Russia exported 4.8m b/d of oil and petroleum products. This matched the export volumes from the same period in 2016. There wasn't, in other words, any decrease in exports, or supply to the international market, despite an agreed reduction in production.
This is because export volumes depend directly on domestic demand for petroleum products. And domestic demand is closely linked in Russia to economic growth—even more so than in other parts of the world. And in 2016-17, the Russian economy was very weak. Domestic demand for oil, therefore, stagnated and even fell. Hey presto, more was left for the international market: exports increased.
What about 2018? The World Bank and Russian economy ministry are both cautiously optimistic about the country's GDP in the coming year, expecting the recession to end and growth to come in at 1.5-2%. But that's still very low and leaves us with a nearly flat forecast for domestic consumption in 2018. The Russian refinery modernisation project will also have an impact on domestic oil consumption. Growing use of more sophisticated and deeper refining processes will lead to a decrease in overall refining capacity and a corresponding reduction in domestic oil demand. According to the energy ministry, refinery capacity in 2017-18 will drop from 5.6m b/d to 5.4m b/d.
Oil production in older fields, the brownfields, fell by 5%
The combination of rising output and weaker demand growth imply that Russia's exports of oil and petroleum products will rise in 2018. Our calculations show that while in 2017 oil and petroleum products exports will amount to around 5.8m b/d, they are quite likely to increase by 5% in 2018, exceeding 6m b/d.
Meanwhile, the other theme for Russian oil in 2018 will be about corporate restructuring. The corporate landscape now is dominated by state companies and a high market share for the largest vertically integrated oil firms. According to estimates from the Skolkovo Energy Centre, following the return of Bashneft into state ownership, the share of companies in which the state holds a majority stake (over 50%) in Russian oil production reached 48% in 2017 (compared with 33% in 2012).
Rosneft alone is responsible for 38% of production and there are grounds to suggest that the company will increase its slice still further. So far, Rosneft's growth strategy has mainly been based on M&A and not on organic growth. In 2013, the company's production grew after the acquisition of TNK-BP, and then subsequently decreased. The 2017 increase in production also followed the acquisition of a new asset: Bashneft, along with its rapidly rising output. The lingering weak oil price, the rhetoric around the "mobilisation economy"—code for more state involvement in the commanding heights—and the need to deal with Opec make state-controlled companies a better counterparty for the state. We don't rule out further centralisation of the oil industry and a new round of M&A in 2018.
Tatiana Mitrova is Director of the Energy Centre at Moscow's Skolkovo Business School, and Ekaterina Grushevenko is an Expert at Skolkovo and the Energy Research Institute of Russian Academy of Sciences
This article is part of Outlook 2018, our annual book looking at energy market trends for the year ahead. To purchase a copy, click here