How crisis hit Russian oil and gas industry?

Author : Carnegie Think tank

Source : 112 Ukraine

The Russian economy is just beginning to get out of quarantine restrictions, but it is already clear that oil and gas will be one of the most affected sectors from the epidemic
20:27, 1 June 2020

gas industry
Open source

The Russian economy is just beginning to get out of quarantine restrictions, but it is already clear that oil and gas will be one of the most affected sectors from the epidemic. Moreover, Russian energy companies are likely to have a harder time than many of their competitors from other countries. This could jeopardize Russia's foreign policy ambitions, which will have to focus on resolving domestic economic problems. It is also difficult for Russia to play a leading role in the US energy triple - Saudi Arabia - Russia.

Related: Russian gas transit through Ukraine almost halved

Beneficial globalization

The Russian economic model was built, especially after 2014, on import substitution, reliance on its own financial resources, and limiting the growth of the debt burden of both the state and corporations. At the same time, the authorities tried to create an "independent" economic system - they developed the Eurasian Economic Union with the dominant role of Russia, increased the share of gold in the reserves of the Central Bank, and so on. All this was supposed to protect the economy from external shocks. But the internal raw materials sector remained the internal engine of this model, which received the strongest stimulus for development due to the fact that the world economy has been on the rise all this time.

Such a model could not ensure high rates of economic growth but managed to maintain stability and accumulate reserves both for the budget and for the commodity companies themselves. The Russian economy enjoyed the benefits of global growth but was never able to learn how to transform them into meaningful economic results. Despite all attempts at modernization, the dependence of the Russian economy on the resource sectors has not declined in recent years. This led to the fact that neither the company nor the authorities were unprepared for a sharp change in the situation in the global economy due to the coronavirus.

The epidemic hit the largest industry in the Russian commodity sector - the oil industry. After all, oil is, first and foremost, satisfying the demand for mobility, both personal and for the movement of goods between countries and continents. The more globalized and rich the world becomes, the more oil is needed. For a long time, Russia, with the predominant role of the oil sector, has received enormous benefits from the globalization process, although it formally opposed the "dominance of Western values."

A coronavirus pandemic could lead to global mobility coming off its long-term upward trajectory and moving into a new equilibrium. The problem is not so much the current collapse in prices, but rather fundamental shifts in demand. If consumers change their behavior for a long time even after the quarantine measures are lifted, and companies prefer to depend less on foreign deliveries that have become less reliable, then the market recovery will take a long time.

This means that years will pass before oil demand returns to pre-crisis levels. In 2020, global oil demand might decline by 7–9%, which will be the worst shock for at least 80 years. Then, of course, growth will follow, but it is not known how long it will take to close the failure of 2020.

Related: Germany considers partial switching to hydrogen instead of Russian gas by 2030

Limitations of OPEC ++

As part of the OPEC + deal, Russia has committed itself to drastically reduce oil production - by 9–10% this year. The last time production was reduced at such rates in 1992–1994. Then, due to the economic crisis in Russia and Eastern Europe, the demand for oil fell sharply, and logistic restrictions did not significantly increase supplies to other markets.

Now, to restore production to pre-crisis levels, it will take three to four years due to the fact that the limits of the transaction will remain until the end of 2021, and companies will obviously reduce investments in the coming years. Russian oil companies have already announced that they will reduce investment costs by at least 20% this year. If production restrictions remain for a year and a half, then there is no point in realizing large investment projects.

Related: Autogas prices continue to grow in Ukraine

Gas for the domestic market

The gas industry is not bound by external restrictions on production and is not so much dependent on global demand from transport, but there are also difficulties due to the epidemic. Gas prices in Europe fell by 40-50% last year, before the collapse of oil prices. The main reason is the increase in supply, especially the global overproduction of LNG.

Now quarantine measures in European countries have also hit demand. As a result, wholesale gas prices in Europe fell in May to $ 50-60 per thousand cubic meters. This is almost 70% lower than in 2018. The consequence was that export prices were lower than domestic Russian gas prices. The domestic gas market unexpectedly became premium compared to exports.

According to our estimates, gas production in Russia may decrease by 7–8% in 2020. In the first four months, the decline in production has already reached 8%. Pipeline gas exports may decline by 11–12% due to reduced demand, warm winters and excess storage reserves. After 2020, the recovery of both volumes and prices is not ruled out, but this may take several years.

Amid a sharp decline in revenue, Gazprom will have to rethink its investment priorities. The investment program of the monopoly for 2020 was initially planned to be 16% less than last year, but it can very well be reviewed and reduced even more. The strategic priorities, most likely, will be the completion of the Power of Siberia gas pipeline and the resource base serving it, as well as the commissioning of the Power of Siberia-2 stopped by sanctions. However, large new projects will have to be forgotten.

Related: Germany's decision not to exempt Nord Stream 2 from EU gas directive is blow to Russia, - ambassador

Reconsideration is soon

A crisis in the oil and gas sector may require Russia to seriously revise both its domestic and foreign policies. Around the world, the crown crisis has shown how vulnerable and fragile economies can be, where almost everything is determined by just a few industries - it doesn’t matter, it’s tourism, flower cultivation or oil and gas production. The size of Russia, its human resources can provide a much more stable diversified structure of the economy. The authorities will need to move from cosmetic to real measures to modernize it.

Russian geopolitical ambitions of recent years have been largely based on energy dominance and the country's importance as one of the world's key energy exporters. But if the world needs less oil in the coming years, Russia's role will also objectively decline. One recent example: apparently, fearing new US sanctions, Rosneft decided to abandon its Venezuelan assets, a key area of ​​its foreign activity.

Related: Average price for autogas still grows in Ukraine

The state will also incur enormous costs due to lower oil prices. According to our estimates, at an average annual price of Urals oil of $ 30 per barrel this year, oil and gas budget revenues will amount to 3.6 trillion rubles, compared to 7.9 trillion last year. The budget deficit may amount to 5–7% of GDP.

Anti-crisis measures to support the economy will require additional costs from the budget. At first, the Russian government was limited mainly to indirect support measures - tax holidays, state guarantees for the affected industries, and so on. More or less substantial direct support to the population appeared only in the third package.

Further, as the scale of economic damage clears, the government will have to increase these costs. This means that the current focus of the Russian authorities will be focused on solving domestic economic problems, and there will be fewer resources and opportunities for foreign policy expansion.

A lot of hope lies in the fact that in the new conditions Russia, together with Saudi Arabia and the United States, could form the “oil three” of the largest producers, which could become something of a mega-regulator of the world oil market. However, do not overestimate the capabilities and viability of this format. A high level of mistrust remains between all participants, and they have objectively different interests.

Related: Is the U.S. using sanctions to elbow Russia out of the European natural gas market?

Saudi Arabia is ready to offer additional discounts to competitors' prices in order to maintain its position in key export markets. The United States did not actually make any formal commitments to reduce production under the OPEC ++ deal and is even considering providing government support for its own oil industry. Russia has little room for maneuver and has to agree to the role of a junior partner in these conditions.

Marcel Salikhov

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