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Gaurav Agnihotri

Gaurav Agnihotri

Gaurav Agnihotri, a Mechanical engineer and an MBA -Marketing from ICFAI (Institute of Chartered Financial Accountants), Mumbai, is a result oriented and a business focused…

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Rosneft Doubling Down To Survive Oil Price Storm

Oil prices are now looking to fall even further. WTI is trading below $41 per barrel and has already breached the six-year lows.

With persistent oversupply in global markets (along with Iran’s upcoming reentry to the market) coupled with the economic slowdown in China and Japan, the bearish trend in the oil markets might persist in coming months.

In fact, some market analysts and traders are even predicting oil prices will fall to $30 per barrel.

The sustained oil price fall since last year has adversely affected global drilling activity, but there is one company that is largely unaffected by this, as it feverishly pursues its drilling activities. Russia’s Rosneft, the world’s biggest oil company (by trading volumes), has actually increased its drilling activities during the last seven months.

While Rosneft is ramping up its production, another Russian giant – Gazprom is now just a mere shadow of its former self. From a market capitalization of $367.27 billion in 2008 to just $51.12 billion as of 3rd August 2015, no other company in ‘world’s top 5000’ has suffered a bigger crash with respect to its market capitalization.

Gazprom “is not being managed as a profit-maximizing entity but rather for all sorts of other political agendas,” said William Browder of Hermitage Capital Management limited. By taking up projects in China and Ukraine that were considered to be financial risky, Gazprom has lost billions of dollars as it has become a major geopolitical tool of the Russian government. So how has Rosneft been able to increase its production amidst all of this?

How is Rosneft able to ramp up its drilling activities in spite of a global slump?

Oil majors around the world have already reduced their spending by $60 billion in 2015. However, this isn’t enough, as analysts from Jefferies Group LLC say that Big Oil needs to further reduce its spending by a whopping $26 billion.

In contrast, the drilling volumes at Rosneft have increased by 27 percent during the first seven months of 2015 where more than 800 new wells were drilled. At a time when oil companies are shying away from newer acquisitions, Rosneft is all set to buy Trican Well Service Limited’s Russian Hydraulic Fracturing business. So how does Rosneft manage to increase spending on its operations and acquisitions when other major oil companies are struggling?

The answer lies in Russia’s weakened currency – the ruble. Thanks to the sanctions on Russia by the European Union and U.S. after the Ukraine crisis, the ruble has weakened substantially against the U.S. dollar and is now trading at almost half of the value it was a year ago. The devaluation in the ruble has reduced the operational costs as oil companies would earn in dollar and pay their expenses in rubles.

Moreover, Russian tax laws have resulted in domestic oil companies bearing just one fifth of the burden related to the total drop in the crude oil prices. “As we expected, changes to Russia's taxation mechanism on the oil sector at the start of 2015 are cushioning domestic companies within the sector from the effects of lower oil prices," said Julia Pribytkova of Moody’s. With a production of more than 10 million barrels per day in month of July, Russia’s oil output has reached its post-Soviet era production levels.

Is the tax cut sustainable for the Russian government and could this enhance Russian oil exports?

Oil and gas revenues account for more than 50 percent of Russia’s national budget revenue. Since oil prices have eroded in the last year (to almost half of what they were), Russia has been one of the most severely affected countries. As Russian oil companies bear just 20 percent of the international oil price burden, the remaining 80 percent is being borne by the Russian government’s state budget through low tax rates. This has resulted in Russia’s oil export duty falling to by 18 percent every month. Currently, the Russian government has little option but to swallow this tax cut as it tries hard to balance oil producers and the Russian budget by increasing its mineral extraction tax.

According to a study by Citigroup, Russia’s exports are still as profitable as they were during the $100 per barrel oil price levels, because of the currency devaluation. It is therefore quite obvious that Russia is set to increase its exports (and add to the supply glut) as the country has no other choice but to produce more oil in order to maintain its market share. This is highlighted by Rosneft’s first quarter profits, which fell by more than 35percent, yet it still decided to increase its production levels.

By Gaurav Agnihotri for Oilprice.com

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