Russia’s Oil Dependency – 4/8/16

Few countries have been hit harder by the collapse of oil prices than Russia. The nation produces the third largest volume of oil in the world at around 10,853,000 bbl/day compared to the US at 13,973,000 bbl/day, Saudi Arabia at 11,624,000 bbl/day, and China at fourth place with 4,572,000 bbl/day. But unlike China and the US, Russia does not consume most of its output. Russia’s oil dependency is apparent in the following 2012 statistics: oil and natural gas accounted for over 70% of the country’s total exports, as well as 16% of the GDP and 52% of federal budget revenues.

You only have to look at the cuts in military spending, once thought to be an untouchable area, to see how far oil revenues must have fallen. Russian defense procurement will drop at least 10% this year, according to the head of the conglomerate controlling much of  Russia’s military-industrial complex. Oil-and-gas revenues funded a 1000% increase in the defense budget since 2000 but now crude oil prices, currently hovering  around $40 a barrel, are set to stay below the $50-a-barrel estimate Russia used in 2016 budget calculations even into 2017. Given strict deficit targets, even once sacrosanct budget areas must deal with reductions in funding. Weak revenues may have played a role in Russia’s withdrawal of forces from Syria, though a desire for the end of Ukraine related sanctions may have also motivated the turn to diplomacy

Sanctions imposed by the EU and the US limit access to credit and imports the Russian economy is in dire need of as it struggles to operate under low oil prices. The country is facing its longest recession in almost two decades. The rise in oil prices after 2000 provided about $1.1 trillion of export revenues when Putin first came into power. But since then oil prices are down 75% from their peak and sanctions imposed after incidents of Russian aggression sent living standards spiraling downwards.

Putin’s crisis policies have placed the bulk of the burden on the shoulders of the common citizen. In January 2014, the average salary of a Russian was $850 a month; January of 2015 saw it fall to $450. As a result, the number of Russians living below the poverty line rose to the highest levels in nearly a decade as the recession continued in spite of government claims that the economy had already bottomed out. The Federal Statistics Service reports that 13.4% of the population were living in poverty in 2015, versus 11.2%, in 2014; levels comparable to those seen during the 2008-2009 global crisis. The government, already cutting spending on all levels, spending rainy day reserves, and raising taxes, has also decided not to adjust for inflation pensions and salaries of state workers.

Most relevant to the energy industry, the Kremlin going so far as to consider taxing the investment funds meant to ensure future oil production. Such a desperate move would mean even hastening the inevitable long-term decline of the Russian oil fields already plagued by age, weather, and new taxes.

“The situation is very serious,” Mikhail I. Krutikhin, an energy analyst at the consultancy RusEnergy, estimating that Russia’s oil production, currently producing a post-Soviet record high of 10.8 million barrels a day, will peak at some point next year.

“The only question is the slant of this line,” he said. “The oil companies are not investing at all in exploration of new deposits because profits on these projects will only come in 10 years. Nobody will invest in these projects.”

Paid in dollars but operating using the battered ruble, Russia’s oil majors are a tempting target for a cash-strapped government. At a price of $100 a barrel, companies were paying taxes of $74, according to Renaissance, a Moscow investment bank, but with oil at $35 a barrel, the tax is about $17, leaving $18 a barrel for the companies. The average cost of producing and transporting a barrel of oil is about $15 so a profit margin of only $3 leaves little or nothing to show for an investment.

Adding to the Kremlin’s headaches is the reality of oil deposits depletion. Many of the wells providing the oil for Russia’s record output were developed before the fall of the Soviet Union and untapped reserves lie mostly offshore or in shale which can be significantly more expensive to develop.Russian companies have not broken ground on a major new field here since 2014 just as Western sanctions took effect and oil prices slumped.

According to the World Bank, Russia’s recovery will take longer than previously forecast.

“Due to a continually adverse external environment, Russia’s journey to recovery will be long and difficult,” the lender said in a report. “The removal of economic sanctions is projected to boost investment, though this will have a relatively modest impact during the forecast horizon due to Russia’s limited growth potential.”

Though the EU is expected to begin easing sanctions this year, few analysts expect the US to change its position before 2017

Print Friendly, PDF & Email

Comments are closed.