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bne May 2020
still a deep discount to Brent which is trading at about $25 at the time of writing. Confusion reigns.
But whatever the price really is, all the possible prices for Urals are below the $25 that the Kremlin seemed to be assuming if its motive really was to crush the US shale industry. Finance Minister Anton Siluanov came out just ahead of the flash crash of WTI prices to boast that the RUB12 trillion ($161bn, 11% of GDP) in the National Welfare Fund (NWF), Russia’s sovereign wealth fund, was enough to cover the budget deficit for
a decade, assuming average oil prices as low as $25. This year the Ministry of Finance is expecting there to be a RUB3 trillion hole in the budget (a third bigger than the RUB2 trillion hole it had in 2014 during the last oil shock) but that there was no need to cut spending, as the missing money could be sourced from the NWF. At that burn rate there is enough in the NWF for four years – and that is before the Kremlin starts cutting spending or raises the very low tax rates on companies and citizens.
But this plan doesn't work if average oil prices are zero, or even if they are, and stay at, $15. In the days after the crash of WTI prices Siluanov was out in public again to manage expectations and dramatically walked back his previous confidence, saying that Russia would have to spend half of the money in the NWF just this year (6.8% of GDP) to cushion the shock from the double whammy of the oil price collapse and the stop-shock caused by the coronavirus (COVID-19) pandemic.
“Demand for oil in April and May could be down by as much as 20 or 30 per cent, while the overall decline in 2020 will be 5–7 per cent, according to various estimates. This means that in six to eight weeks, storage facilities could be full, pushing oil prices even lower than the record lows seen recently, when the price of Urals crude fell to about $10 a barrel,”
says Marcel Salikhov, an analyst with the Carnegie Moscow Centre. “Oil prices at a twenty-year low and a dawning realisation of the scale of the fall in demand helped all the key producers to see that any agreement is better right now than no agreement at all.”
If the MinFin really does need RUB7 trillion years of budget deficit cover and stimulus spending then the NWF will be exhausted before the end of 2021. Given the government’s previous form in prior crises it is very clear that the Kremlin will not run down its reserves because they play a key strategic role, as they make Russia Inc. sanctions proof. If Russia has
to go into the international debt market to raise significant amount of cash to fund deficits is becomes vulnerable to sanctions and Putin simply won’t go there.
In this light it was no surprise that the Kremlin decided to eat humble pie and signed off on a new OPEC++ production cut deal that will reduce production of oil by 9.7mn bpd on April 13. Under the terms of the new deal Russia will cut 1.8mn bpd, which is significantly more than before. All in all, the Russian
Opinion 65 cut is 18% of the total OPEC++ cut, which is the same share
as it had before under the old deal.
“The main risk is that after being temporarily shut down, the oil wells may not be able to return to their previous operating capacity, or will require a major overhaul to do so. As a result, there may be irreversible production capacity losses, and
“Oil wells may not be able to return to their previous operating capacity, or will require a major overhaul
to do so”
some deposits may simply not be viable at current prices,” says Salikhov. “This is by no means inevitable, and much will depend on how well the oil companies prepare for the new regime.”
Moreover, Russia now cuts a million barrels a day more
than the Saudis do, a reversal from the previous deal. And despite Russian calls for the US to finally join the OPEC+ structure, Putin only managed to get vague commitments from US President Donald Trump, who claims to have brokered
the deal. From the Russian perspective the new deal was a humiliating climbdown.
The terms of the tussle between the US, Russia and Saudi have changed and it appears the Kremlin has badly miscalculated. Going into the OPEC+ meeting on March 6 the key elements to a clash between the players was a combination of the cost of lifting a barrel of oil, the amount of money a country has
in reserve to deal with deficits, and the breakeven cost of oil needed to balance a budget.
The Kremlin was calculating that it was in a strong position, as its lifting costs are much lower than those in the US and only slightly higher than those in Saudi Arabia. As Siluanov said, the Kremlin believed it had enough reserves to survive low oil prices for a decade, but then the circa $500bn Saudi Arabia has in reserves is also enough to cover deficits for at least five years. But in a long fight the Kremlin believed that Russia’s budget breakeven price of circa $40 vs the $80 Saudi Arabia needs gave it the upper hand.
That all works with oil at around $25, but it doesn't work with oil at around $0 or even in the teens. Now the terms of the conflict are simply who can most easily turn oil wells on or off and control the flow of production. Here Saudi Arabia has a big advantage over Russia, where most of the fields are mature and have become technically more difficult to work. With many Russian fields, if you turn off the production it is not clear if you can turn it on again later.
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