By Ben Aris

06-02-02 Increasing fears over a growing domestic oil glut wrecking havoc with prices have spurred the Russian government into action. Moscow slashed export duties for the second time in a month and also launched plans to build a strategic reserve.
Thanks to the un-Russian warmth of the winter, the Kremlin has already decided to end restrictions on fuel oil exports, which have limited oil companies to exporting only 25 % of their fuel oil output, as of January 15. Usually, Russia lifts fuel oil export restrictions in mid-spring, after the end of heating season.
Given the creaking bureaucracy of the Russian political machine, the new measures are surprisingly timely and show up the ongoing dialog between the government and big business. It also highlights the importance the Kremlin puts on development of the oil sector.

Prime Minister Mikhail Kasyanov signed a resolution to cut the export duty on fuel oil in half as of February 1. The duties are due to fall from EUR 20 to EUR 10 perton. The export duty on crude oil is also to drop from EUR 23.4 to $ 8 per ton, while the export duty on light and mid-weight distillates and diesel exported from Russia to outside the CIS will fall from EUR 39 to EUR 25 per ton. The Economy Ministry said that if the domestic market prices don't stabilize, then the tariffs may be reduced further in order to encourage greater exports.
The cut will mean some $ 250-300 mm in additional savings for companies involved in the sector. Surgutneftegaz, which exports about half of its fuel oil output, will be the biggest winner. The move will probably upset OPEC, which foisted a production cut of 150,000 bpd on Russia at the end of last year. Russia's state oil pipeline operator Transneft said at the end of that thanks to wintry weather in the northern ports, Russia has already passed this mark, but it is a bad time to be boosting exports.

Analysts say that the cut in duties will bring some short-term relief to the oil industry, but Russia is simply passing the buck to the international markets. A rise in refined product exports will feed through to the international market and start to affect oil prices at the end of the first quarter, about the same time as the agreement with OPEC expires.
"It is going to get ugly," says Christopher Weafer, the head of research at Troika-Dialog brokerage in Moscow. According to Weafer, the OPEC states are already cheating on their own promised production cuts even as Russia is about to increase supplies.
Weafer also noted the combination of unhappy coincidences now facing the world oil market: Global demand has been weak due to a mild winter; US stocks were unusually high at the start of the winter thanks to fears of Afghan-inspired instability in the Persian Gulf region; and Russia continues to increase crude production apace.

Figures released show that OPEC countries produced an average of 22.8 mm bpd in January against a quota of 21.7 mm bpd. Iraq accelerated its rate of pumping recently and can increase it by another third to 3 mm bpd. Russia currently produces about 7 mm bpd (including the 2.5 mm bpd of domestic consumption) after a 7.7 % increase last year. Further increases are expected this year. And with its storage facilities nearly full, if the rumours are true, there is little Russia can do other than pour more into the growing international lake.
One solution is to sit on the excesses. At a meeting of the special commission on export pipelines, chairman Aleksandr Grigoryev proposed that the state set up a strategic oil reserve similar to that of the United States. The commission has storage space for refined products that can be converted to hold 5 mm tons (36.5 mm barrels), or about 3 months worth of exports. (Troika estimates that some 3.4 mm tons, or 24 mm barrels, of crude is looking for a home at the moment.)

The idea of establishing a strategic reserve has been ridiculed by banks, which point out that Russia is a net exporter of oil, while the United States is a net importer, and that the country has reserves of about 95 bn boe, enough to last 100 years. If the oil is already stored in the ground, they ask, then why pump it up only to store it in tanks?
But the idea is not as silly as it first appears. A state-owned storage agency would allow oil companies to continue increasing their output and investments while the Kremlin decides how much Russian oil will go on to the international markets.
This would suit the government fine as the Kremlin has made it clear that it wants to see oil companies increase production as fast as possible to break the country's addiction to high prices. But this goal comes with consequences -- namely, that if too much oil is released into the market, prices will crash.
Companies are driven by market forces. There is little incentive for them to cut production to hold up prices due to fears that their neighbours will cheat, so they will always export as much as possible. However, the Kremlin is driven by political as well as economic considerations. It is also worried about the relation between oil prices and the macroeconomic health of the country.

At the moment, Moscow has little leverage over Russian companies' export strategy except insofar as it regulates access to Transneft's pipes. But with a big strategic reserve in place, the state will become a player. To a limited extent, it could set international oil prices to suit its macroeconomic goals. This is significant since there is a big debate going in the Kremlin at the moment over the question of what is the "best" price for oil. Extremely high prices fuel inflation in Russia, whereas too-low prices prevent the government from collecting enough tax revenues. All the companies like high prices, but some are more sensitive to low prices than others.
President Vladimir Putin's time in office has been marked by his desire to increase the state's control in strategic industries. Although the ousting of Rem Vyakhirev as CEO of Gazprom and its venal management has been hailed as a blow for the forces of good, the practical upshot was the Kremlin now exerts a control over the company that Putin's predecessor Boris Yeltsin could only dream about.

The irony of the reserve is that it is a mechanism that sounds like it comes straight from the "How to be an Oligarch" handbook; the key to business in the 1990s was not to gain control over a company but to grab its cash flows. In the oil industry, this meant owning the ability to sell the oil without necessarily owning the company that produced it. The beauty of the government's new scheme is that the oil companies will remain in private hands, but the state can force them to sell their oil to the reserve.
The problem with this plan is the lack of clarity on the question of just how the oil will be collected and what price the state will offer. The government must also be tempted to make whatever profit it can on the arbitrage between domestic and international prices -- again like the oligarchs. The value of the 5 mm tons of oil that would be put into the reserves comes to about $ 225 mm at current domestic prices -- compared to $ 555 mm at current world market prices.