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Russia’s Self-Inflicted Oil Crisis

Russia

The timing could not have been worse for Russia to provoke a spat with Saudi Arabia over oil production quotas in early March. Moscow’s decision to withdraw from the OPEC+ agreement restricting oil production in order to maintain higher oil prices triggered a harsh reaction by Riyadh that sent oil prices spiraling down to below $25 per barrel in the midst of the coronavirus pandemic (Oilprice.com, March 24). The price of Russian Urals oil dipped even lower, under $19 on March 18, which will deprive the Russian budget of some $3 billion a month (Vedomosti, March 19).

The Russian economy is likely to suffer the most devastating consequences of the oil price war - just as it bore the heaviest impact of low global oil prices five years ago. This time around, however, the injury is self-inflicted, as an angry Saudi Arabia not only decided to ramp up production but also moved to grab Russia’s oil market share around the world (see EDM, March 1923).

On March 6, Russia’s Energy Minister Aleksandr Novak declined to accept new oil production quotas after April 1 when the current OPEC+ deal expires (Oilcapital.ru, March 10). The move targeted primarily debt-burdened U.S. shale oil companies, which were already under pressure by the advancing COVID-19 pandemic. Moscow has long resented that the U.S. oil sector has continued growing unobstructed by cartel policies and has steadily overtaken Russia and Saudi Arabia as the world’s leading oil producer. Russian energy officials took advantage of the coronavirus spread globally to deal a blow to indebted American shale oil producers who need an oil price above $40 a barrel to remain solvent (Asia Times, March 18).

But Moscow also needs an oil price above $40 to balance its budget (Lenta.ru, March 11), for which oil and natural gas revenues make up to 40 percent. The current budget is calculated at an oil price of $42 per barrel (Interfax, March 1), and that, combined with foreign currency reserves of $570 billion, could indeed provide a cushion - but only in the short term. A sizeable foreign currency reserve helped prop up Russia’s budget when the Organization of the Petroleum Exporting Countries (OPEC) drove oil prices down in 2014, targeting oil companies in the United States. The drop in oil prices then overlapped with the Western-imposed sanctions against Russia for invading Ukraine. The budget, calculated at an oil price of $96 per barrel at the time, had to be revised when oil prices dropped to $45 and revenues decreased by $160 billion, one third of Russian overall exports (Cbr.ru, May 2015, accessed March 25, 2020). Social spending programs had to be put on hold until oil prices recovered a few years later, resulting in increased social protests in 2018 and 2019 (Kommersant, June 22, 2019).

Today, Russia is in a much riskier situation as its long-term financial stability is threatened if oil prices do not recover. The Kremlin evidently did not expect that its disagreement with Saudi Arabia would lead to a plunge below $20 per barrel. Officials are now playing down the long-term impact on the economy. Russia’s Finance Minister Anton Siluanov has said he is not concerned about the fall in oil prices, because Russian oil companies have recently accumulated a large safety cushion (RBC, March 20).

If a price agreement is not reached soon, however, Russia’s prospects would be grimmer than in 2014–2015, because oil prices are 50 percent lower, Western sanctions remain in effect and new ones were introduced, and global oil demand has shrunk due to the coronavirus pandemic. In addition, Saudi Arabia has been successful in snatching some of Russia’s markets, including an oil purchase deal with Azerbaijan’s State-Owned Oil Company (SOCAR) (Ona.az, March 13). Not surprisingly, Moscow quickly settled price negotiations with Minsk and agreed to sell crude oil to Belarus at a significant discount of $15.70 per ton (Tut.by, March 23; see EDM, March 24).

Related: Saudi Arabia And The U.S. Could Form The World’s Newest Oil Cartel

In the meantime, Russian oil companies have started revising their investment plans due to the collapse of oil prices. Lukoil was the first to admit it will have to cut investment by $1.5 billion, mainly for new projects. Its vice president, Leonid Fedun, said that with oil prices below $35 per barrel, oil production in Russia will begin to decline from 2022–2023 (Kommersant, March 20).

It is becoming increasingly clear that if oil prices do not recover, President Vladimir Putin is unlikely to deliver on his promise to increase social spending. The plan, announced in Putin’s annual State of the Nation address on January 15, includes 4.1 trillion rubles ($65 billion at the time of the address) in social spending by 2024 to assist the poor, increase pensions, help families and boost the national birth rate (Kremlin, January 15).

The period of economic hardship coincides with President Putin’s attempt to secure his position as de facto president for life, after he initiated changes to the Russian constitution (see EDM, January 16March 1619). The authorities scheduled a nationwide constitutional plebiscite on the amendments for April 22, but this was subsequently delayed amid the coronavirus pandemic (Meduza, March 25). The COVID-19 outbreak in Russia and several weeks of inept or counterproductive government response - the authorities have been habitually hiding the facts and arresting activists who report on coronavirus cases - are making Russian citizens even more anxious. Putin suspended work for all non-essential laborers from March 28 to April 5 in an effort to curb the infection (Meduza, March 25). The pandemic will undoubtedly take an additional financial and social toll in a time of decreased oil revenues.

By Margarita Assenova via Jamestown Foundation

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  • Filip FromBerlinGermany on March 27 2020 said:
    Not surprisingly, Moscow quickly settled price negotiations with Minsk and agreed to sell crude oil to Belarus at a significant discount of $15.70 per ton (Tut.by, March 23; see EDM, March 24).

    Really per TON?! This would be even under the Saudi production costs of 3 US-$ per barrel which seem to be the lowest in the world or at least lowest at major oil project or for the whole country? I dont know if only one field has this very low 3 US-$ production cost or the whole country, but I could imagine the whole country as the difficult projects are almost untouched yet and like Russia the needed very high oil price (compared to production costs the needed prices are extreme high) is only a thing of budget planning and because they make up a large or the largest portion of exports..

    1 ton = ~6.3 barrels if I remember? That's why 15.70$ is per barrel or?! Minsk could sell otherwise a ton for 10-times as much, or almost that much, to Western Europe or to companies close to the baltic sea or to the oil refinery there, they only had once for the 3 very small countries some years ago...
  • Steven Conn on March 26 2020 said:
    The oil price war is neither self inflicted because its the Saudis that started it at the bidding of US and its shale producers. Russia is BETTER equipped than in 2014: it has much larger forex reserves ($510 bn vs $570 bn), lower foreign debt ($730 bn vs $480 bn), and a special $120-$150 billion rainy day cushion that is spent in rubles, so it grows as the ruble weakens. Also, Moscow has a more flexible currency today than in 2014 when it stubbornly kept it at the $1/33-34 rub. Its budget is slated for $42.5/barrel instead of $100/barrel as in 2014. Moreover, the bankruptcies and production cuts in US shale, production cuts in Canadian oil sands and North Sea will reduce the oil on the market by mid-late summer, unless Trump tells Saudis to stop their silliness earlier, since it is devastating US shale producers, who are debt ridden and don't have a flexible currency to work with. We have seen no credible evidence or data to show that Russian oil exports are being pushed out.
  • Mamdouh Salameh on March 26 2020 said:
    This article is full of biased views and distorted facts and mistakes and I will endeavour to point them out.

    It is not Russia which provoked a spat with Saudi Arabia. It is Saudi Arabia who initiated an oil price war against Russia. Russia didn’t withdraw from the OPEC+ production cut agreement. It merely refused to agree to deeper cuts arguing very logically that any new cuts or a deepening of existing cuts will be futile and will have no positive impact on oil prices while the coronavirus outbreak is raging.

    The real reason for the declining oil prices is the coronavirus outbreak. The price war is a by-product of the outbreak.

    Saudi Arabia threatened to flood Europe with oil and offered a price discount for its Arab light crude in order to undermine Russia’s share in Europe’s oil market. Russia responded by discounting its Urals crude to defend its market share.

    President Putin learned the lesson of the 2014 oil price crash and ordered extensive diversification of the Russian economy. As a result Russia’s economy can now live with an oil price of $25 a barrel for years compared with $91 for Saudi Arabia’s.

    Moreover, the lifting cost per barrel of Russia’s largest oil producer, Rosneft, is now lower than that of Saudi Arabia’s oil giant Aramco. This is due to the falling ruble against the dollar. Russian oil companies earn dollars and other hard currencies for their exports but pay for their operations in ruble. The lower the ruble slides against the U.S. dollar, the lower the production costs of Russian oil companies. As a result, Rosneft’s costs per barrel have fallen from $3.1 to $2.5 compared with a $2.80 for Saudi Aramco.

    That is why Russia will win the price war hands down.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London

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