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Osama Rizvi

Osama Rizvi

Osama is a business graduate and a student of international relations. Currently working as freelance journalist, covering commodities and geopolitics.Osama is a regular contributor at 'Modern Diplomacy'…

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The Secrets Behind Russia’s 2016 Oil Success

Oil rig

For every one dollar reduction in the price of oil, Russia suffers a staggering two billion dollar loss in its revenue. On top of the economic sanctions slapped on Russia following the annexation of Crimea, one may consider the record Russian oil production of 11.247 mbpd nothing short of a miracle. But how did Russia, while other oil producers were in doldrums, keep its nodding donkeys busy pumping oil? In the U.S., the rig count was falling every week and oil companies were filing for bankruptcy. Yet the Russian production in October touched a post-Soviet Era high. The secret to its success appears to be a combination of tax measures, the dollar value and the advantage of low-cost production.

The Russian oil majors, Rosneft and Lukoil, which account for almost half of the country’s oil production, increased their capex spending last year. Rosneft’s increased capital expenditure last year by 30 percent, with a 33 percent increase in the first half of 2016 compared to the same period in 2015.

(Click to enlarge)

There were many factors at play here. The tweaking of Russia’s corporate taxes and export duties is one of the central ones. Recently, the Kremlin increased corporate taxes but at the same time reduced the export duty by 9 percent in December, thus offsetting the effects of each. Sputniknews reported that “The Russian oil industry has managed to perform well. Both investment and production are growing despite low oil prices. Investment in the energy sector – which should raise by 15 percent in 2016 to 3.6 trillion rubles ($55.5 billion) – has materialized, despite the challenging market environment.”

Despite its ability to adapt to low prices, Russia has pledged to contribute a 300,000 barrel cut in production following the recent agreement reached in Vienna on November 30th. The OPEC and NOPEC producers have reached an entente to take out a total of 1.8 million barrels from supply. Saudi Arabia is taking the biggest hit, reducing 480,000 barrels. While total OPEC production will be curtailed by 1.2 mbpd. Different analysts are skeptical regarding the longevity of the deal given the record of Russia’s lack of cooperation in such deals. The deal went into effect on the 1st January, 2017 and will continue for 6 months with an interim meeting in March—where producers meet to assess the effect of the production cut.

Russia, following the inauguration of Mr. Trump – who could lift the current sanctions – may plan to ramp up production, sabotaging the deal and causing oil prices to plunge once again.

Mr. Fereydoun Barkeshli, Chairman of the Vienna Energy Center and Advisor to the International Institute for Energy Studies, shared his thoughts with me as follows:

As for Russia's oil embargo and how Russians continue to raise production, it is important to note that Russia sells most of its oil under term agreement. As such buyers have to abide by the purchase contracts that often run into five years or even more.

Further, Russia is such a huge crude oil producer that markets cannot easily ignore it. Having said that, most countries managed to close their eyes on the oil embargo. This is particularly true when it comes to Russian natural gas exports to the E.U., where 34-35 per cent of gas consumed comes from Russia and Europe might risk its gas flow if it insists on an oil embargo against Russia.

On the question of Cooperation he was positive saying:

As for OPEC-NOPEC cooperation, Russia is certainly an important player in the market and its support for market stabilization is important. OPEC has been trying to get Russia on board for over three decades and now Russia has finally agreed to cut production by some 300,000 B/P/D. This by itself is a success for OPEC. This indicates that Russian have now understood that the free lunch is over. Moscow may not fully adhere to the agreed cut, but OPEC is already one step closer to a global cooperation for comprehensive market stabilization. This is in line with the OPEC market strategy. Remember that the organization was originally founded by five oil-producing countries and there are now fourteen. I reckon that the next phase would well be to get the United States’ shale gas production on board, though that is even more complicated due to the nature of the U.S. energy structure.

For Russia to increase its production is simply a matter of choice. Ronald Smith of Citigroup, in an article in the Financial Times, while explaining the reason for the increase production in Russia says:

“We see two general reasons: First, contrary to common misconception, Russia’s oil production is not a high-cost venture. Instead, the typical Russian barrel of oil resides far down the cost curve, generating economic value even at oil prices below $20 per barrel, although the bulk of that economic value goes to the Russian government via taxes, rather than to producers in the form of profit.

Second, both Russia’s oil tax regime (explicitly) and the free-floating ruble (in effect) are tied to the price of oil. The combination of an automatically-adjusting tax burden and ruble work to act as a very effective cushioning mechanism for wellhead operating margins.”

Russian oil production in December has stayed at record levels. Also, it has stressed that any production cut target will be gradual and will be completed by June. It may be supposed that Russia is ramping up its production to compensate for the after-effect of the production cuts. The reduction in oil export duty seems to cement this notion. Meanwhile, media sound bites by Russian President Putin and Saudi Arabia’s Oil Minister Mr. Al-Falih continue to support an increase in oil prices. But for how long? That is another question.

By Osama Rizvi for Oilprice.com

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