Economy

Doubt remains over Russia's oil production cut promise

Kremlin is willing to cut oil production in line with OPEC deal, but making it happen is easier said then done, experts say

08.12.2016
Doubt remains over Russia's oil production cut promise

By Emre Gurkan Abay

MOSCOW

It will be a difficult task for the Russian government to realize oil production cuts agreed at the OPEC meeting in line with other world producers, experts say.

Russian Energy Minister Alexander Novak announced last week that they would reduce their oil output gradually to 300,000 barrels per day (bpd), starting from the first half of 2017, following OPEC's decision.

However the government is not in full control of Russia’s oil industry, unlike the oil sectors in most Gulf countries. Top officials of the country’s major oil producing companies have previously voiced their reluctance to reduce their production levels.

Igor Sechin, the head of Russia’s largest oil firm Rosneft, which produces nearly half of the country’s oil, recently said that they were not planning to reduce their oil production levels.

"Why should we do it?" Sechin asked and voiced his doubts that other oil producing countries such as Saudi Arabia and Iran would also comply.

According to a recent survey, OPEC's November oil output increased by 370,000 barrels per day (bpd) to 34.19 million bpd compared to a month earlier -- the highest in recent history.

“There is no mechanism for the distribution of obligations between the oil companies regarding an oil production cut,” Vladimir Milov, the president of the Institute of Energy Policy, a Moscow-based independent think tank, said.

Milov said the production cut would be equivalent to 15 million tonnes of oil per year and at cost of $50 per barrel, meaning a loss of about $5.5 billion.

He noted the skeptic statements made especially by the head of state-owned companies in the country on the forced reduction of production, bearing in mind that the cuts are set against a background of already committed investments, signed contracts and the need for conservation for the costs of well closures once a well is depleted.

Alexander Dyukov, the head of Gazprom Neft, the oil company of Russian state gas firm Gazprom, in October said that they were not ready for a production cut, while Lukoil’s vice president Leonid Fedun said in an interview with Russian TV that they hope there would be some sort of compensation from the government.

However, Kremlin spokesman Dmitry Peskov announced Wednesday that Russian oil companies would not receive compensation for the production cuts.

“You would think that in Russia’s command-administrative system, it is easy to order companies to reduce production and they will have to fulfill the order,” Milov said, “However, this is easier said than done. In the absence of the implementation of such a mechanism to achieve a rapid reduction, it will not be easy,” he warned.

Russian companies enjoying ruble's depreciation

The ruble's depreciation allowed investments in Russia’s oil industry to remain attractive, as the oil exporting companies earn in dollars but pay costs in rubles.

This caused companies like Rosneft, Lukoil and Gazprom Neft to increase their investments in new fields.

Rosneft even bought a 50.08 percent stake in Bashneft for about $5.3 billion -- Russia's fastest growing oil company with production of 400,000 bpd.

Marcel Salikhov, the head of the economics department at the Moscow-based Institute for Energy and Finance, is more doubtful of the prospects of Russia joining the production cut agreement with OPEC.

“I think that it would be better for Russia to abstain from production commitments as it's hard to implement for Russian industry,” he said, adding that however, the oil cut decision has already been made

Salikhov said that the cut will be orchestrated through natural declines in mature fields in the country, as most Russian oil production comes from fields at a declining stage.

Russian crude and condensate production averaged 11.21 million barrels a day in November, compared with the historic record level of 11.23 million barrels a day in October.

“The big question is of course the distribution of the burden. It's not yet clear how the cut will be allocated by companies,” Salikhov said.

However, Igbal Guliyev, chief researcher at the International Institute of Energy Policy and Diplomacy of MGIMO University in Moscow, believes that the oil price increase will compensate for the losses incurred by Russian oil companies from the production decline.

“It’s expected that the oil price increase will result in additional income amounting to $9-$19 billion in 2017,” he said, adding that the additional few dollars to the oil price per barrel may result in a very significant daily revenue growth.

Nonetheless, Guliyev also stressed that major oil companies in the country, such as Rosneft, will feel the impact of an oil production reduction.

“Rosneft will have to suspend old and unprofitable projects, and to carry out efficiency upgrade procedures. This will have some negative implications for the company and employees. The company is reluctant to carry out massive procedures, but nevertheless, in future it will positively impact the Russian economy,” Guliyev said.

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