The result is known: the oil price collapsed, the cartel called Opec-plus met for a special meeting to agree on drastic cuts in production and get the raw material price out of the cellar.
The Opec plus agreement with significantly reduced production volumes has been in force since May 1st. Saudi Arabia’s Ministry of Energy even announced on Monday that it would voluntarily cut its oil production by another million barrels from June to just 7.5 million barrels a day. That would be at the level of 2002. And the Saudi government in Riyadh asked Russia to do the same as the world’s largest oil exporter.
So Igor Setschin is back on the train. The head of the state-controlled oil company Rosneft, the world’s second largest after Saudi Aramco, is resisting cutbacks. The West Siberian oil fields, on which half of Russian production is extracted, are heavily depleted. They were mostly started up deeply in Soviet times, with robust but not high-tech systems.
For years, water vapor and chemicals have been trying to keep emissions high. The import chemicals required have been expensive since the considerable ruble devaluation. A year ago there was a scandal, crude oil contaminated with chemicals was pumped up to the refinery in Leuna. Polish and Belarusian plants were severely damaged.
A look at the most important production area shows how bad the situation of Russian oil fields is: In the western Siberian Chanty-Manssijsk, the number of wells was increased by two thirds after new access to oil fields. The amount subsidized nevertheless fell by 15 percent between 2008 and the previous year.
For decades, Russia’s strategy has been to pump as much crude oil out of the approximately 200,000 wells. Until 2016, the Kremlin never got involved in negotiations with Opec, but always took advantage of it when Saudi Aramco, a producer that was important to balance oil demand, cut production.
Later, Moscow often failed to keep the promise of funding cuts given to Opec, Riyadh said. Aramco turned off feed pumps, Lukoil, Rosneft, Gazprom Neft and others opened their pipes further.
Revenge of outdated technology
This is now the end: “We will implement the agreement 100 percent and all companies have taken responsibility for it,” announced Russian Energy Minister Alexander Nowak on the Opec plus agreement. Russia is currently cutting back on funding for the first time since the 1998 ruble crash. Moscow, like the Saudis, had committed on May 1 to shoulder most of the agreed cuts of 9.7 million barrels (about ten producers of daily oil consumption).
Nowak had incurred the anger of Putin’s intimacy Sechin. Russia’s pledged 18 percent cut to 8.5 million barrels a day is a “revolution in the Russian oil industry,” said Mikhail Krutichin. Because to achieve the effect of a wacky feed pump in Saudi Arabia, “you have to turn off up to 150 in Russia,” says the partner of the renowned Moscow consulting firm RusEnergy.
But even for the post-corona period, Marcel Salichow from the Moscow Carnegie Center warns: “The main risk is that the oil wells will not be able to return to their previous operating capacity after a temporary shutdown.”
The pressure drop after the source was closed could be too great and “irreversible losses in production capacity” threatened. In addition, “some deposits at the current prices are simply not profitable,” says Salichow.
It could get worse
Revenge, adds Yekaterina Gruschewenko, an expert at the Skolkowo Management University’s energy center, that Russian oil companies have been taxed too high for years and that they have not been granted tax incentives for massive investments in modern production techniques.
The triad of outdated technology, forced volume cuts and falling prices led to the Conora pandamic that Russia would lose five to 13 percent of its gross domestic product in the energy sector alone, calculated Gruschewenko. Russia’s central bank is currently assuming a four to six percent decline in economic output for the current year.
It could get worse: Russia has production costs of around $ 13, Saudi Aramco only $ 3 a barrel (159 liters each). The Saudi oil fields are also significantly younger, not located up to several kilometers deep and not as close to their end of production as the Russian ones. Therefore, according to experts, they are more flexible to turn on and off.
In addition, a Saudi borehole produced significantly more crude oil than a new one in an old Siberian field. This means that Saudi Arabia can survive low-price phases much better.
Putin vs. Crown Prince
In addition, only the Minister of Energy and Aramco – both in fact instructed by the powerful Crown Prince Mohammed bin Salman – decide in the kingdom in the oil sector. In Putin’s empire, however, energy minister Nowak not only has to capture the stubborn Sechin with his contacts to the Kremlin chief, but also Gazprom and private oil billionaires who control Lukoil and Surgutneftegas.
Before the corona crisis, expert Krutichin had expected a maximum production of 570 million tons annually in 2021 as the historical high point of Russian oil production and then a drop of 44 percent by 2035.
Then his homeland would say goodbye to his previous role as an oil export country and only be able to serve his own needs. It is still unclear whether the decline will go even faster if the end of the pandemic fails to start up stale oil wells.
Russia also has new large deposits, but they are far behind the Arctic Circle in the deep sea. The country would need the most modern drilling and mining technology there, which cannot be supplied due to the Western Russia sanctions. Loans or bond placements for Russian oil companies are also prohibited in the West.
Saudi Arabia’s problems
But the situation is also dramatic in Saudi Arabia’s oil industry. Aramco had to announce a drop in its profit this week by a quarter to $ 16.7 billion for the first quarter, which is not yet fully covered by Corona.
Treasury Secretary Mohammed Al-Jadaan also made drastic budget cuts of $ 26 billion to melt away the $ 500 billion in currency reserves. The US big bank Goldman Sachs had foreseen that in 2023 if not counteracted massively. In order not to let the oil price collapse again, Aramco has announced another cut in its production by one million barrels a day.
Dealers also report that the world’s largest oil company will cut its exports from June for European, American and at least a dozen Asian customers. “It is politically important for the US and Donald Trump” that the Saudis send less oil into the Atlantic basin, said Olivier Jakob from the Petromatrix consulting firm. “It is also a gesture to the Russians that the Saudis are not out to destroy the European market,” added the expert.
“The kingdom has clear fiscal constraints to get higher prices,” said Helima Croft, commodity strategist at RBC Capital Markets. The country had already been forced to take painful austerity measures.
Demand forecast increases
Russia’s leadership is also facing strong economic headwinds – in addition to the coronavirus that is rampant in the country. “President Putin’s popularity has dropped to its lowest level in two decades,” says Croft. The recent rise in oil prices is therefore giving both countries at least some air.
According to Riyadh, Russia should also make further cuts in funding. So far, Setschin has once again said “Njet”. But Michael Hiley from energy trader LPS Futures doubts that Saudi Arabia will voluntarily implement the reduction. The fact that Aramco is ready to cut another million barrels “means that they have no buyers for that million, so what appears bullish is actually bearish.”
However, the International Energy Agency (IEA) has revised its recently extremely pessimistic forecast for oil demand upwards. It expects a 20 percent drop in oil demand in the second quarter, previously the agency had assumed 23 to 25 percent. “The picture is still very bleak,” said IEA chief Fatih Birol.
“But the worst is likely to be behind us.” Investors are also convinced of this: since the beginning of the month, the US oil grade WTI has increased by almost 50 percent. The price of Brent North Sea oil rose 17 percent over the same period.
More: Fragile rally on the oil markets.