Russia and OPEC: It's war

Nov 20, 2001 01:00 AM

by Ben Aris

It's war. OPEC threw down the gauntlet, saying it would not cut production unless non-OPEC countries followed suit. And Russia picked the gauntlet up and said it wouldn't.
The problem with cartels is that they don't work unless they have a virtual monopoly over the product in question. If they don't, then cartel members cut production to drive the price up, while non-members step in, raise production and make huge profits at the cartel members' expense -- literally.
Until recently, OPEC could ignore Russia. It had a large enough share of the world market that it did not need to pay attention. But no more. With its oil output soaring, Russia is having a bigger and bigger impact on prices. And OPEC, already worried about rising Russian production, decided that the time had come for a confrontation that was evitable. So now that Russia and the cartel are facing off, the question is which side can bear the pain longer, for if both continue to produce at current levels world oil prices will fall.
"The game of 'chicken' between OPEC and Russia [looks] set to continue, and until it becomes clear that OPEC will not back down, we will see further weakness not only in the oil price but also on the RTS [Russian Trading System]," Sam Barden of Renaissance Capital commented.

On Friday, November 16, the price of benchmark Brent crude fell to $ 16.80 per barrel, its lowest level since June of 1999. The drop instantly took the steam out of the Russian stock market, which had just climbed to a 2001 high; the RTS index, for example, reached 236 as Russian President Vladimir Putin began a three day love-in with US President George Bush. But the market had fallen back to 213, slightly above where it has been all year.
The government is determined not to decrease oil production. As Monitor has said several times before, the Kremlin's plan is to boost production at all costs so that Russia can earn the same volume of cash it has been enjoying all year even if international prices fall. In this way, Putin hopes to break Russia's addiction to high commodity prices.

OPEC's plan, though, is to force Russia to go cold turkey while it is still weak. Cartel members hope that the pain will be too much and that Russia will respond by joining OPEC. But Prime Minister Mikhail Kasyanov spelled out the Russian policy, saying: "Russia is not an OPEC member and should pursue its own interest in this issue."The Russian premier also said he would not rule out the possibility of minor cuts in oil exports in order "to keep prices in a fair band".
Russia cut production by a token 30,000 bpd, but considering that it produces about 7 mm bpd the cut was meaningless. Publicly, Kasyanov says Russian oil policy is driven by two factors: the desire to keep prices in the "fair" band of $ 22-28 a barrel and the drive to meet demand in Europe, the main buyer of Russian oil.
Opinion amongst the top Russian oil companies is mixed. LUKoil thinks Russia should follow the example of OPEC, while Yukos says Russia should continue to increase exports. Yukos' chief Mikhail Khodorkovsky thinks oil export cuts would force Russian oil companies to reduce their investments. This in turn would deprive the industrial sector of orders worth as much as $ 6 bn, and Russia's market share would be taken by Azerbaijan and Kazakhstan, he says.

Oil accounts for about a quarter of Russia's GDP and about the same share of exports. As such, any fall in prices is sure to hurt, and the price has already dropped below the critical level of $ 18.50 per barrel, the minimum point at which the 2002 budget is supposed to balance. The question now is what impact further price falls will have on the country.
The Kremlin has drawn up three scenarios for different prices. The best-case scenario forecasts an average oil price of $ 23 per barrel, which was the case for most of 2001. In this scenario, Russia grows strongly and the budget enjoys healthy surpluses. Hard-currency reserves will increase by $ 4-5 bn, the government will have no need to borrow money and inflation will remain in the low teens.
The middle-case scenario of $ 18 a barrel would mean no increases in hard-currency reserves, but there would still be no need to borrow abroad. Spending would have to be reigned in, though. The worst-case scenario posits an average oil price of $ 15 per barrel. At this price, hard-currency reserves would drop by $ 5-6 bn, and Russia would have to tap international markets for about $ 1 bn in 2002. In 2003, Russia would then have to borrow another $ 2 bn and restructure another $ 1 bn in international debt. Inflation would be between 13 % and 18 %.

Even the worst-case scenario would not spell disaster, however. Russia currently has record reserves of more than $ 38 bn, and the country's top oil companies have built up impressive war chests of $ 1-4 bn in cash. Under the circumstances both the International Monetary Fund (IMF) and the Paris Club have said they would be willing to help ease Russia's pain with loans or debt restructuring deals.
"The impact of declining oil prices on sentiment towards Russia is always far greater than the impact on its fundamentals. The oil price would have to fall very low levels -- e.g. $ 12 per barrel -- and stay there for at least six months for it to critically undermine Russia's economic and budgetary position," says Barden of Renaissance Capital.
But it may not come to this. The Merrill Lynch investment bank lowered its previous forecast of the world oil prices for the fourth quarter of 2001 from $ 25 to $ 21 per barrel. The bank also lowered its oil price forecast for 2002 from $ 25 to $ 23 per barrel.

Analysts are a little more pessimistic about Russia's prospects under these scenarios. In a report, Alfa Bank estimates that Russia will not be able to increase its reserves with prices of $ 20 a barrel. At $ 15-$ 17 per barrel, it would have to borrow $ 2 bn in Eurobonds, not $ 1 bn as the government says, the report asserts. But it also says that even with prices as low as $ 15 a barrel, Russia's economy will still grow, albeit at the more anaemic rate of 1.6 % a year. (Roughly speaking, each $ 1 fall in oil prices knocks about 0.5 % off Russia's GDP, so growth stalls at around $ 12 a barrel.)
Yet Russia is in a much stronger position than it was in late 1998, when prices fell to $ 10 and aggravated the financial crisis. As both the country and oil companies have large reserves, the Kremlin can afford to continue playing chicken with OPEC for at least a year. Recent debt buy-backs and early payments have reduced Russia's debt burden from 60 % of GDP to 40 % (which compares well to most Western countries), a move that further insulates Russia from low prices. Finally, the economy will continue to do well through 2002 on the momentum built up this year before the pain of low prices kicks in beginning in 2003.
So with Putin at the helm of the Kremlin, it looks like OPEC's power over the market has been broken and oil prices may trend lower from now on. This in turn will accelerate the process of consolidation in the Russian oil sector -- a process that has already begun.

At a recent investment conference, Yukos' chief said he thought there would be only six vertically structured Russian oil companies in 10 years time. According to Khodorkovsky, these companies will include LUKoil, with annual production of 80-100 mm tons of oil and gas production of 30 mm tons of oil equivalent; Yukos, with 65-80 mm tons of oil and gas production amounting to 20-30 mm tons of oil equivalent; Surgutneftegaz; Tyumenneft (TNK); and, "more than likely", Sibneft and Gazprom.
Oil production in Russia will amount to 420 mm tpy in a decade's time, with gas production amounting to 700 mm tons of oil equivalent, Khodorkovsky said. Oil exports to Europe will amount to 200-250 mm tons and domestic consumption will amount to 105-140 mm tons.
Meanwhile, Mikhail Zadornov -- a former Finance Minister and current deputy head of the Duma's budget committee -- said that the budget could sustain an oil price of $ 12 per barrel for one year without major problems. This might, however, slow the rate of growth in Russia's economy, and Moscow might have to resume borrowing from the IMF.
Nevertheless, Russia still seems to be in a better position than OPEC, since members of the cartel start to feel economic pain whenever oil prices fall below $ 20 per barrel. Russia may therefore be heading for a win in this round of the battle.

Source: NewsBase
Market Research

The International Affairs Institute (IAI) and OCP Policy Center recently launched a new book: The Future of Natural Gas. Markets and Geopolitics.

Cover_242-width

The book is an in-depth analysis of some of the fastest moving gas markets, attempting to define the trends of a resource that will have a decisive role in shaping the global economy and modelling the geopolitical dynamics in the next decades.

Some of the top scholars in the energy sector have contributed to this volume such as Gonzalo Escribano, Director Energy and Climate Change Programme, Elcano Royal Institute, Madrid, Coby van der Linde, Director Clingendael International Energy Programme, The Hague and Houda Ben Jannet Allal, General Director Observatoire Méditerranéen de l’Energie (OME), Paris.

For only €32.50 you have your own copy of The Future of Natural Gas. Markets and Geopolitics. Click here to order now!


 

Upcoming Conferences
« June 2018 »
June
MoTuWeThFrSaSu
1 2 3
4 5 6 7 8 9 10
11 12 13 14 15 16 17
18 19 20 21 22 23 24
25 26 27 28 29 30

Register to announce Your Event

View All Events