Russia Undermined by Oil Glut – 1/25/16

Few countries have been hit harder by the oil glut than Russia. After years of relying on oil revenue to fund government programs and forays abroad like invasions, undermining nearby governments, and bombing Syria, Putin is being forced to address monumental budget shortfalls. Oil money makes up around half of federal revenue and one-third of national export output. Western sanctions over Crimea and Ukraine have done some harm to Russian economic strength but a prolonged oil price collapse would be devastating to investment which could have far reaching implications. Russian companies already openly admit that a decline in oil output from the countries primary reserves in Siberia is unstoppable. The IEA projects that Russian oil production has already peaked and Western sanctions restrict the sale of technologies that could help tap shale-oil.

Russian oil companies are weathering the storm relatively well thanks to three factors: a favorable tax system, cheap costs, and the devaluation of the ruble. For now, the export and extraction taxes are pegged to the price of oil, though the government has already suggested that it would abandon planned reductions. In addition, existing pumps are low cost extraction points in contrast to offshore, shale-oil, oil-sand, or deep-sea reserves giving the companies room to breath. Also in the oil companies’ favor, the devaluation of the ruble has been a boon since it is common in the industry to sell crude for dollars while paying wages and buying equipment with rubles. The result is much cheaper extraction at the expense of real incomes for workers.

For Russia to access the technology and expertise it needs to begin accessing shale-oil reserves as a means of replacing aging pumps, it will need the lifting of sanctions leveled against it by the West. Though it has been two years and a six month extension was recently put in place, leaders in France and Germany are considering a move to bring Russia in from the cold. Frustration with the situation in Ukraine is still high but the refugee crisis and rising tensions has put many elected officials in an awkward position.

Apparently Russian interference in the affairs of other nations is looking useful for keeping the chaos contained. This acceptance of Russian corruption and militarism is not especially surprising when radical Islam has long since become the more pressing issue for the West. More fallen regimes or a Saudi-Sunni/Iran-Shia conflict would do much more harm than letting Russia a few neighbors.

Russia’s situation is important to understand because it is the second-largest exporter of oil behind only Saudi Arabia, and its refusal to curb output has helped to keep oil prices at lows not seen in more than a decade. OPEC has made it clear that it cannot come to an agreement on production cuts while Russia continues to maximize output. And, unfortunately for oil producers, Russian collusion seems unlikely while it can pump at even marginally profitable levels and make grabs for market share.

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