Streetwise Professor

December 13, 2008


Filed under: Commodities,Economics,Energy,Politics,Russia — The Professor @ 9:50 pm

Oil rallied this week (but still finished well below $50/bbl) primarily on reports that Russia would cooperate on output cuts with OPEC.   Dmitri Medvedev has hinted that Russia might actually join the organization.

There are several reasons for skepticism.   First, Russia has dramatically reduced its oil export duty, and is contemplating a further cut:

Russia cut oil export duties to $287 per tonne from November 1, from $372.2 in October, in response to calls by producers who feared making losses on overseas shipments. Russia’s senior energy official, Deputy Prime Minister Igor Sechin, had lobbied for an even lower November tariff of $195.20.

. . . .

RIA Novosti reported that Russia could reduce oil export duty to USD 117 per tonne to USD 119 per tonne from the current USD 192.1.

Mr Alexander Sakovich deputy head of the customs payments department at the ministry said the average price for Urals crude on world markets in the monitoring period from November 15 to December 9 inclusive was USD 44.5 per barrel. He said the price could continue to change until December 15 given high volatility on the market.

Mr Sakovich said duty on light petroleum products could be cut to $91-$93 per ton against the current USD 141.8 and on heavy petroleum products to USD 49 per tonne to USD 50 per tonne from the current USD 76.4.

The Russian government decided to set export duties on oil and oil products on a monthly basis from December 1st and abandon the previously accepted bimonthly practice.

The most effective way for Russia to curtail oil exports (which is the only way it would have an impact on world prices) is to keep its export tax relatively high.   Lowering the export tax encourages exports, and is contrary to statements that it will cut output.   Sechin’s support for lower duties is especially important in this regard.

It is possible to both cut export duties and cut exports, but this would require the imposition of export quotas.   Just keeping the taxes higher would be a more sensible and straightforward approach.   Although higher export taxes would hurt Russian oil exporting companies–most importantly, Sechin’s Rosneft–this effect could be mitigated by some sort of compensation to these firms.   (To work, though, this would require that the compensation not be linked to current exports or output in any way, as that would just offset the effect of the tax.)

The fundamental inconsistency between promising to cut output/exports in collaboration with OPEC on the one hand, and cutting oil export duties on the other makes me question the credibility of Russia’s statements.     Moreover, formal monitoring and enforcement of members’ adherence to quotas within OPEC are doubtful enough, and informal promises from Moscow with no prospect of enforcement seem a very weak reed to lean on.   Indeed, if I were OPEC I would be very leery of Russia’s representations.   Russia has every incentive to encourage an OPEC output cut–and then to produce as much as possible to exploit the higher prices.   If Medvedev and Putin think that attending the OPEC meeting and promising cooperation make it more likely that OPEC will indeed cut, they’ll do those things.   The intent to adhere to those promises is highly doubtful, however.

Liam Denning expresses different reasons for skepticism in the WSJ:

Look at an atlas, and you will see that all of the members of OPEC sit within or very close to the Tropics.

That Siberia lies far to the north is one reason why Russian President Dmitry Medvedev’s hints about joining the oil group amount to mere posturing. The Organization of Petroleum Exporting Countries’ primary lever for influencing oil prices is raising or lowering members’ output — sometimes several times a year.

Try doing that when the Siberian winter freezes dormant wells closed, meaning they have to be drilled again. Meanwhile, summer thaws churn up the ground, bogging down maintenance equipment. In Russia, once you drill a well, it pays to keep it pumping.

In theory, the Kremlin could stockpile reserves to adjust export volumes. But this would take time and incur big costs in an economic crisis.

It also isn’t clear why Saudi Arabia, OPEC’s de facto leader, would want Russia to join the quota system. In 2007, the Saudis exported 7.9 million barrels a day, according to the U.S. Energy Information Administration. Russia exported seven million barrels. Saudi Arabia would risk seriously diluting its influence in an already fractious group. And for what? Does anyone think Moscow would abide by OPEC policies if it didn’t suit it?

In reality, Mr. Medvedev is dressing up Russia’s inevitable output decline — largely resulting from the state’s tightened grip on the energy sector — as a planned move co-ordinated with OPEC. Second, with the economy still a leveraged play on energy prices, and a possibly destabilizing ruble devaluation on the horizon, he is trying to talk up the oil market.

Far from hinting at increased Russian influence, the president’s words carry more than a hint of desperation.

Denning’s point about the inherently less flexible nature of Russian oil production is of great interest.   It means that actual Russian cuts in the short run are more credible in the longer run than cuts in, say, Kuwait. Kuwait can cut today, and increase output relatively easily in the near future.   If Russia cuts today, it is effectively committing itself to cut for a considerably longer period.   Knowing this, it is less likely that Russia will choose to cut.   It would be in a real jam if it cut in conjunction with OPEC, only to have the latter’s members (predictably) renege on their commitments weeks later.   In that case, Russia would have the worst of all worlds–lower output and low prices.

So, I concur with Denning’s basic argument that Medvedev is just talking his book (as traders say), and that he is trying to get some price action in exchange for cheap talk.

Rather than listening to Medvedev, or Putin for that matter, I would pay attention to the export duty.   That is the primary lever that Russia can pull to affect exports and hence world prices.   If Russia raises the duty, it means it is serious about cutting output.   If it keeps the tax low, or cuts it further as the Novosti article suggests, all the talk about cutting output in conjunction with OPEC is just that–talk.

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  1. What does the U.S have to say about OPEC trying to spike gaz prices up?

    I hope they swing into action by trying to diminish OPEC influence on oil.

    A gaz taxation in U.S would help…as long as you pay the consumer back with their income tax.

    Obama should also force GM to stop building big truck and move toward cars that could bring gaz usage down…Revive the electric car.

    Comment by Barack Obama — December 14, 2008 @ 10:25 am

  2. Canada’s Globe and Mail has a nice analysis of Russia’s musing about whether to join OPEC. A few excepts and my comments:

    [Start of citation]Despite the tough talk, many Western analysts believe the Russian participation will essentially be political and symbolic.

    “I’m skeptical that you are going to see any real action out of them,” said Greg Priddy, global oil analyst at political risk consultancy Eurasia Group.

    “I expect you’ll see them claiming credit for the declines that are already taking place rather than make any real cuts.”

    Russian oil production peaked at 9.9 million barrels a day in 2007, eclipsing Saudi Arabia as the world’s largest producer, according to the U.S. Energy Information Administration. But the EIA expects it to decline to 9.8 million barrels a day this year, and drop by another 100,000 barrels a day in 2009.

    Mr. Priddy said he expects Russian production to drop even more dramatically – between 200,000 and 300,000 barrels a day – as a result of underinvestment in high-cost fields.

    He said Russian companies face unpalatable choices if they are required to cut production further – shutting in crude, or leaving oil down the hole, which would erode the productive capacity of mature fields.

    Instead, it will fall to Saudi Arabia, Kuwait and the United Arab Emirates to shoulder the additional burden of production cuts. Price hawks like Iran and Venezuela – which are more desperate for the revenues – are already thought to be cheating on previously announced reductions.[end of citation]

    As the article notes, and as we have been discussing in the past, Russian production was already declining even when oil was trading for $147 a barrel due to Russia not investing in developing new fields to replace old fields. For Russia to claim that it is cutting production to support the efforts of OPEC is like me claiming that I am responsible for the sun rising in the East.

    The comment about shutting down mature fields eroding their productivity is important as most Russian fields are now mature. Given that Russia has not been investing sufficiently in new fields, this would threaten Russia’s future prosperity if it were to undermine production in existing fields. The oil could be pumped out and then stored, but that requires infrastructure and more spending and time to build the required storage facilities. All of which Russia is running short in Russia.

    So, the only hope for Russia is that Saudi Arabia will cut back drastically on production, but this may not be likely:

    [Start of citation]In recent years as supplies grew tight and prices soared, Saudi Arabia invested many billions of dollars to boost its productive capacity and it may be reluctant to shutter a significant portion of that capacity.

    The alternative is to allow crude prices to sink lower, thereby forcing out of the market the higher-cost, non-OPEC supply, including Alberta’s oil sands producers.[End of citation]

    I will have to check, but I believe the Oil sands are profitable if oil is at least $20-a-barrel. What low prices do is curtail new investments and new production. So, if the price of oil will have to go down low enough to really put a crimp in oil sands production, this would mean oil at prices that will drive the Russian state into bankruptcy. [I had to add in this last comment for Da Russophile who has been eerily quiet these last two days. ;)]



    Comment by Michel — December 15, 2008 @ 8:03 am

  3. How stupid has it been in driving off western partners to explore and fund new fields. Khordorkovsky years ago saw the production decline coming and was going to make a deal with Exxon, Chevron, one of the big American O&G producers, I forget which. That gesture was part of his death knell. Russia’s production will decline.

    I think $30/barrel is the profitable cut off for oil production, Michel. In a conference call Diamond Offshore, one of the bigger offshore drillers if I remember correctly stated they needed $40/barrel to be profitable. The Canadian oil sands need $60/barrel because their extraction costs are very high. There is an excellent investment board, CWEI, at Many of the folks are in the O&G industry. They are very knowledgeable regarding the trends and have the best stats. Check the posts with the most recommendations and follow the thread to save time there. It’s an education.

    Chavez unless he wants a revolution on his hands will have to keep a revenue stream coming in. I think the shrewd Sunni Arab OPEC folks, primaily the Saudis, will see this interim as a gift to do damage to Iran. Iran’s nuclear ambitions are directed at them too. And, of course, the Russians have thrown their patronage behind Iran’s nuclear bomb ambitions. The Saudis also do not want a destablized Iraq in their neighborhood. This is purely my opinon and it’s why I’m guessing oil stays cheap for awhile barring any crazy terrorist activity to a major oil field.

    The new administration would be smart to throw a federal tax on gasoline to dampen demand rising with these low prices and use as an infrastructure fund.

    Comment by penny — December 15, 2008 @ 9:41 am

  4. And this from the Financial Times: Supertankers store 50m barrels of oil

    “Oil companies and traders are storing at least 50m barrels of oil in supertankers in a clear sign of supply outstripping demand as the global economy slows.

    The surge in floating storage, – enough to meet France’s oil imports for a month and the biggest since late 2001–, is likely to push the Opec oil cartel, which is due to meet on Wednesday in Oran, Algeria, to make a deeper production cut to reduce stocks. Storing oil in tankers is unusual as it is significantly more expensive than inland.”

    Of course, when asked the OPEC ministers say: “Everybody is supporting a cut.” But, will they actually carry through with cuts? I doubt they will be able to cut deeply enough and fast enough to deal with a growing glut.


    Comment by Michel — December 15, 2008 @ 7:58 pm

  5. “[I had to add in this last comment for Da Russophile who has been eerily quiet these last two days. ;)]” – Michel

    There’s this annoying thing called a life that keeps getting in the way.

    In any case I’ve already explained my take on things and gave you the link, and events haven’t changed enough to force a cardinal rethink.

    Comment by Da Russophile — December 16, 2008 @ 10:02 pm

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