Putin’s Oil Deal Is Humiliating But Unavoidable

(Bloomberg Opinion) -- For Lukoil PJSC’s billionaire shareholder, Leonid Fedun, Russia’s decision to sign up to the OPEC+ oil deal was akin to its signing of the 1918 Treaty of Brest-Litovsk, which dragged the country out of the First World War. Both were humiliating, but necessary, he implied. The alternative was far worse..Back in early March, Russia, with its strong foreign currency reserves and low-cost producers, had expected to ride out the misery of tumbling crude prices. Unable to extend an existing output reduction deal with its fellow oil exporters, it spied an opportunity to squeeze out those seen by Moscow as free riders: namely, the U.S. shale producers who benefited from others’ production restraint, only to flood the market with supply..In the end, though, the damage inflicted by the coronavirus lockdowns on oil demand was too great. The potential geopolitical gains from being seen to participate in a solution — and the losses from being seen to hamper one — were too significant. Storage was running out. Russia agreed to cut..The real challenge lies ahead. Saudi Arabia and Russia have said they will split the burden of the reductions, cutting 5 million barrels a day between them initially from a baseline set at 11 million. That’s half the total cuts agreed by the OPEC+ group (including the old OPEC nations and other producers). Yet Moscow’s concessions will mean far greater technical risks and future costs for its oil companies, which have had to become increasingly ingenious to keep mature fields alive. That means compliance with the deal’s targets looks trickier too..Russia could have coped for longer with rock-bottom prices. It has a rainy-day fund for just such times. Yet President Vladimir Putin needed to ease the economic pain from Covid-19 at home, and higher crude prices would help. He will also hope that participating in a deal that satisfies U.S. President Donald Trump may pay dividends elsewhere, say, in sanctions. Unfortunately, what makes sense at the virtual negotiating table isn’t always straightforward in practice..To hit its target for May and June’s cuts, Russia will need to remove 2.8 million barrels a day from its reported March liquids production levels. Even if you exclude gas condensate, the Oxford Institute for Energy Studies estimates that’s still 2 million barrels to be cut — one-fifth of the country’s crude production and double what commodities trader Trafigura estimated that Russia could concede, and what Moscow itself had indicated. It would take Russia back to production levels last seen in 2003..The difficulty isn’t cutting back. Indeed, that’s the easy bit. The trouble is that Russia’s mature fields account for some 80 percent of its production, and they aren’t easy to just turn off and on again. Cuts need to be made without hurting companies’ ability to ramp back up at a reasonable cost. Plus they’ll need to be delivered in a way that doesn’t make the remaining production uneconomic. Kirill Tachennikov, an analyst at BCS Global Markets, estimates that half of these fields aren’t technically equipped to easily alter supply. And that’s before considering other implications, such as local employment and changes to electricity consumption..The question, then, is how Russia’s commitment will be spread between producers, not all of them state-controlled. So far, Energy Minister Alexander Novak has said the companies agree that radical measures are needed, but there’s scant detail on how they’ll deliver them. Rosneft PJSC accounts for almost 40% of Russian production, but it may find it easier to argue its way out of some restrictions thanks to its crude production that’s pre-sold to China. Producers such as Tatneft PJSC, with a greater share of mature fields, will suffer more..There are some levers that Russian producers can pull: Turning more crude into profitable refined products, for example. There may be some room too for maneuver around the conversion between Russia’s official numbers, in metric tons, and the statistics in barrels per day. Vitaly Yermakov at the Oxford Institute for Energy Studies points out that much of Russian production, say from Eastern Siberia and Sakhalin, is of lighter oil, so that means producers get more barrels from their oil, which should make the cuts more manageable..There are some silver linings, too: The weather is warming, which may reduce some of the difficulties in making these changes to ice-bound facilities. The weaker rouble will also reduce costs and may protect future projects, as their cost in dollar terms come down. And at the best of times it’s hard for OPEC+ to monitor compliance, especially for pipeline exports..Avoiding short-term pain, though, looks impossible..This column does not necessarily reflect the opinion of Bloomberg LP and its owners..Clara Ferreira Marques is a Bloomberg Opinion columnist covering commodities and environmental, social and governance issues. Previously, she was an associate editor for Reuters Breakingviews, and editor and correspondent for Reuters in Singapore, India, the U.K., Italy and Russia..©2020 Bloomberg L.P.

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Putin’s Oil Deal Is Humiliating But Unavoidable

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