Over the first quarter of 2016, the Saudis and Russians were in a mood to offer up a ‘freeze’ of their respective oil production levels provided other rival producers did likewise.
With oil futures having slid below $30 per barrel at the start of the year and the respective production levels of both countries already at record highs, they felt the market needed something to latch on to. However, in the months that have lapsed since then, following a marginal price recovery caused by a slowdown in US production and outages from Canada to Colombia, the combative market mood has returned.
Most Middle Eastern members of the Organization of Petroleum Exporting Countries (OPEC), led by the Saudis, are in no mood for a compromise on the production front, but neither is Moscow, with the oil market pretty much back to the days of the recent glut minus some US barrels and non-OPEC barrels, and a much more dour demand outlook.
While Russian market ambitions cannot be questioned with the country’s oil production already lurking near Soviet era highs, whether the current level can be maintained or increased remains open to different projections.
Never one to shy away from a subject shrouded in ambiguity, investment bank Goldman Sachs told its clients in a note on 19 July that it forecasts Russian production growth to accelerate further, with output hitting 11.7 million barrels per day (bpd) by 2018, an increase of almost 600,000 barrels per day from 2015.
The market stood up and took notice of the Goldman forecast, because according to the International Energy Agency (IEA) projections, Russia’s output would actually fall by 160,000 bpd over the same period. Yet, optimism on the Russian front is not exclusive to Goldman.
Analysts at Morgan Stanley, see the country’s production growing steadily from around 11.1 million bpd in 2015 to 11.5 million bpd in 2020, despite sanctions and lower oil prices. They point towards two factors: first, the sharp decline in the ruble means that oil prices have fallen much less in ruble terms.
Second, under the current tax regime, the government absorbs a disproportionate part of oil price changes, rather than the companies. Research firm GlobalData has also expressed optimism that Russia’s production will be on the rise.
Five planned projects are going into commercial production in Russia this year and several could reach peak production as early as 2017. “The intensification of development activities and growing levels of exploration in Russia signals operators’ confidence with the new normal of the low-price environment,” says Anna Belova, a senior analyst at GlobalData.
Russian president Vladimir Putin ceremoniously opened the Arctic Gate Marine Oil Terminal on 25 May. The appropriately named facility provides access for Russia’s Arctic-sourced crude to both European and Asian markets.
The terminal was specifically timed to coincide with the commencement of commercial oil production at the Novoportovskoye field. Novoportovskoye is just one of five major planned oil fields scheduled to come online by year-end in Russia, and combined, their peak capacities promise to bring over 500,000 bpd of crude onstream.
“When viewed in the context of the sustained resilience of Russia’s mature fields, these projects promise that the country’s two-year streak of record-breaking crude output is set to continue,” Belova adds.
It is becoming manifestly apparent that the resilience displayed by some US oil players in a low cost environment, based on operational efficiency and productivity gains, is being matched by their Russian counterparts via their low cost exploration environment and tax advantages facilitated by the Kremlin.
According to Fitch Ratings, Russian producers should be able to maintain stable ruble-denominated capital investments for several years as the progressive tax regime and ruble flexibility provide a buffer against low oil prices.
After all, unlike international players, Russian producers have avoided large investment cuts as their capital expenditure (capex) is mainly pegged to the ruble, while operating cash flows have remained stable in ruble terms due to the currency’s depreciation against the dollar.
Dmitry Marinchenko, Associate Director at Fitch, says, “In 2015, cumulative capex of Fitch-rated Russian oil players increased by 13% on an annualized basis in ruble terms; we expect it to stay unchanged in 2016 and to fall by mid-single digit numbers in 2017-18.
“This is supported by operational statistics: in 2015, the volumes of development onshore drilling in Russia, measured as meters drilled, increased by almost 12% year-over-year, and rose further by 9% year-over-year in the first quarter of 2016.”
Now the Russian government is moving to overhaul the old tax framework in a bid to improve both its and the producers’ fortunes. Russian companies have been lobbying for years for a profit-based taxation system, saying it will spur production and better reflect exploration costs and exposure.
Based on official documents, a recent Reuters report noted that a new profit-based taxation system could soon be applied first to pilot projects with total production of between 200,000 bpd and 300,000 bpd.
Under the new scheme, the budget may still lose up to RUR50 billion ($771 million) if it is introduced under an oil price of $50 per barrel, as is the case at present. However, loses could be eliminated if production increases by a third.
More than anything, it is the timing of the move that sends a signal to the wider market – Moscow is more than ready for a crude tussle. Only problem is, production upticks elsewhere alongside Russia’s, and not very many reasons around to fire-up global demand could mean only two things – more short-term bearishness, and more industry pain.