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Is A Permanent Decline Coming For Russia?

Is A Permanent Decline Coming For Russia?

The OPEC meeting in Doha is less than two weeks away, and the markets are not sure what to make of it – oil prices have seesawed back and forth following every comment from OPEC and Russian officials about the possibility of a production freeze.

The summit originally generated a lot of buzz because Russia was finally convinced to come to the table with OPEC, raising the possibility that the two sides could cooperate on oil production limits. Since Russia and OPEC account for more than 40 percent of global oil production combined, their potential cooperation can move markets. They tentatively agreed to freeze their output levels, seemingly agreeing on collective sacrifice. Related: $120 Oil As Soon As 2018?

For Russia, however, there does not appear to be much of a downside to agreeing to production limits. That is because Russia is at post-Soviet record highs for oil production. Even though Russian output rose to 10.91 million barrels per day in March, 2016 could mark a permanent peak in output as its aging fields enter decline.

Much of the recent gains came from smaller companies. Russia’s largest companies, on the other hand, are struggling to keep production from falling. The state-owned oil company Rosneft saw production fall by 0.7 percent for the month.

Moreover, Rosneft will have to step up its efforts if it is to avoid a more serious decline. Rosneft is expected to spend $15 billion on its Soviet-era oil fields over the next three years, a prodigious sum that is necessary just to keep output from falling. Rosneft’s chief Igor Sechin recently told Russian President Vladimir Putin that drilling would increase by 30 percent in 2016, even though oil prices are so low. That comes after Rosneft drilled much more aggressively in 2015 while its production only rose by 1 percent. Related: Unfolding The World’s Biggest Oil Bribery Scandal

The problems will grow over the longer-term. The Russian energy ministry sees the very real possibility that Russian oil production enters long-term decline, possibly even falling by half by 2035. Russia’s major oil fields are decades old, so it will be increasingly difficult to prevent output from falling. At the same time, Russian oil companies are not discovering new sources of supply that could replace that lost output. The Arctic offers one area where very large reserves could be exploited, but western sanctions have blocked the participation of major international oil companies, which could help Russian companies pull off the expensive and tricky Arctic drilling operations.

Meanwhile, Russia’s natural resources minister said in late March – with an eye on the Doha meeting – that Rosneft will likely lower its output this year. Rosneft actually did not comment on his remarks, but the minister’s comments were likely meant to demonstrate Russia’s willingness to cooperate with OPEC in Doha.

Saudi Arabia seemed to pour cold water on the Doha meeting when it said that it would only participate if Iran did as well. But the meeting is set to go ahead, and on April 5, Kuwait’s OPEC governor said an agreement in Doha was likely, reassuring the markets, while also suggesting that the markets would balance later this year. Related: Can A Divided OPEC Agree On Anything In Doha?

But, from Russia’s perspective, there is little sacrifice involved. Russian output is expected to decline by 20,000 barrels per day on average this year, according to OPEC’s latest assessment. With little room on the upside, that explains the willingness to work together with OPEC to put a cap on their output.

Separately, Reuters reported that Russian sources thought oil prices at $45 to $50 per barrel was an appropriate price that would allow for enough global supply to go offline, allowing for markets to adjust. "The level of $45-50 (per barrel) is acceptable from the point of view of market balance: if prices go higher shale oil production could start to recover,” the Russian source told Reuters.

By Nick Cunningham of Oilprice.com

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Leave a comment
  • Steve Blazo on April 08 2016 said:
    The idea of permanent decline requires commodities to never return to high prices. This is cyclical and will continue to be so indefinitely. Shale does make a game change in oil but not completely and other commodities will also bounce back.

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