Russian position moving, but deal still unlikely

ESAI Energy LLC reports on possible Russian reaction to continued downturn.

Russian Energy Minister Alexander Novak confirmed Russia’s readiness to meet with producers to discuss oil production. Such meetings are not unprecedented and in the past Russian officials have attending OPEC meetings without making any commitments to limit Russian production.

But things are different this time. For one thing, Russian oil companies may support a deal. Only two days before Mr. Novak’s announcement, Lukoil vice president Leonid Fedun suggested Russia should cooperate with OPEC. The suggestion raises the prospect of Lukoil, and potentially other oil companies, cooperating should Russia strike a deal to limit production.

The economics of Russian production provide a glimpse of how painful current prices are. According to ESAI Energy’s analysis in the accompanying chart, when the Urals price is US$30/bbl, a producer’s net revenue after paying the crude export duty and Mineral Extraction tax is US$17. But since their costs are paid in rubles, the value of which has plummeted, lifting costs and pipeline transport from West Siberia are roughly US$8/bbl. These numbers indicate Russian producers can withstand prices as low as even US$20/bbl without them having a significant impact on production in 2016. That said, oil companies like Lukoil and Rosneft, which together account for 5.5 million b/d of Russian production, might participate in production limits were the Putin regime to pursue them.

The absence of a real challenger to Vladimir Putin’s leadership and his high approval ratings enable Russia to ride out low prices and focus on ensuring Russia’s long-term role in the global oil market. This perception reinforces the conventional wisdom that Russia will not agree to production cuts.

Nevertheless, as the red bars on the chart below shows, government revenue from the oil sector is plummeting. If OPEC proposes to Russia production limits that do not undermine Russia’s long-term objectives, and key Russian producers back the deal, Russia may indeed agree to production limits. Such a prospect seemed all but inconceivable until now. But then again the lower oil prices since the beginning of the year and little sign of a recovery may upend conventional wisdom. There is a real chance, however, that Russia is ready to bargain this time, eliminating one of the potential impediments to a grand bargain. We still believe the absence of concessions by Iran and thus other AG producers will scuttle a grand bargain to cut output.

Adapted by David Bizley

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