We cannot exclude the possibility of new amendments to taxation system

18 january 2016 | Rossiyskaya Gazeta

‘Oil prices’ rebound has been postponed until 2017. This has nothing or almost nothing to do with international profiteers, Iran being the main variable at the oil market today after the lifting of its oil export limits,’ said Alexander Kurdin, the Head of the Department for Strategic Studies in Energy of the Analytical Center, in an interview to Rossiyskaya Gazeta.

Alexander Kurdin
Alexander Kurdin
Department for Fuel and Energy Sector

Mr. Kurdin, can we stop oil production?

Mr. Kurdin: No, we cannot. This has to do with the nature of the industry with its high capital and low operating expenditures.

That is to say, if we have invested in an oil deposit, then even if the prices are low, it is still more profitable to keep pumping oil to cover our capital expenditures at least partly. Production will go down only if the price drops below the level of operating expenditures.

What level is that?

Mr. Kurdin: Operating expenditures are quite low. Even at the most expensive deposits they are between 40 and 45 dollars a barrel. We can see that in the US production slows down when the prices drop to 40 dollars.

In Russia operating and transport expenditures are usually under 15 dollars a barrel, so we are not likely to see any significant production cuts. Of course, exploration investments are in a poor state and problems are mounting there, but if the prices keep low only for a year or so, there are no significant changes to production. However, in the case of a long term price drop the situation is quite different.

Half of the federal budget is made up of oil and gas revenues, and the budget for 2016 is based on a 50-dollar-a-barrel average price during the year. Does it mean there will be a revision?

Mr. Kurdin: It is possible.

How big are the cuts likely to be?

Mr. Kurdin: We estimate that a drop in oil prices from 50 to 40 dollars a barrel would result in a 2 percent of GDP deficit of the federal budget, which amounts to 1.5 trillion rubles.

This is on top of the 3 percent deficit which is already reflected in the budget law. Considering that budget expenditures are currently set at 16 trillion, they will have to be cut down by about 10 percent. This problem is imminent even now.

Who or what is behind this drop of oil prices from 115 to 30 dollars? Did the fact that oil is not just a marketable commodity, but one of the global financial assets, contribute to the situation?

Mr. Kurdin: Financial factors may have a role to play, but only as enhancers of certain trends. Imagine a stone is thrown into water and circles are spreading on the surface. In our case the circles are the price variations, but the stone that caused the ripples has to do with the more fundamental factors - demand and supply.

We did a study on the relation between the oil market and financial markets - commodity derivatives, currency and stock markets. What we saw is that there is a relation, but the direction is from oil prices to financial markets, not vice versa.

As soon as oil prices become volatile, commodity derivatives begin to trade more actively. There is a simple explanation: when oil prices start going up and down, financial markets get a chance to make profit on that. However, the original impulse of this volatility is of course the physical excess or deficit of oil.

Oil prices dropped almost four times over 18 months, and the demand/supply margin is only 1.5 percent, which makes for about 1.5 million barrels overstock?

Mr. Kurdin: This is not an impossible situation given the low demand and supply elasticity at commodity markets, and the oil market specifically. Which means that any slight change in the volume of demand and supply, say, caused by the appearance of shale oil, may result in serious price volatility.

You see, when you get a good potatoes crop, potatoes are plentiful at the market, prices go down and people start buying more potatoes while at the same time lowering the consumption of pasta, for example. If there is an overstock of milk, you could do what they did during the Great Depression in the US - throw into the river. The oil market is different.

If demand grows by, say, 1.5 million barrels a day, there are usually no free capacities to match that. Hence you cannot get more oil, because to increase production you need serious investments and it takes years to achieve that, so prices go up. However the reverse is true as well. You find a new large deposit, there is more oil in the market - prices go down...

This is exactly what has been happening lately?

Mr. Kurdin: Yes. Will people start buying more petrol now? Not necessarily, because in some countries petrol prices are largely made up of taxes, and in Arab countries in the East, for example, petrol is subsidized and it costs next to nothing anyway, so people will use about the same amount of fuel as before.

This means that if there is more oil in the market, consumer behavior essentially does not change, even when prices drop very significantly. Oil is kept in reserves, and at some point there is simply no space for it - all the tankers, barrels and drums are full. Then the producer is ready to give oil away for free, but nobody will take it anyway, even when it costs next to nothing.

What happened over the past 18 months is normal, there is no conspiracy involved, no speculative trade?

Mr. Kurdin: No. Prices at commodity markets that have to do with fossil extraction are always volatile, and this is why dependance on their export is a dangerous tendency for economies.

At the same time I cannot exclude the possibility of a financial speculation factor. Traders tend to increase the price movement up and down. The current situation is exactly the case when turbulent commodity prices give ample opportunities for speculation for those investors who like to risk.

They are playing low at the moment, are not they?

Mr. Kurdin: No, there are different strategies out there, both for the bulls and the bears. They used the same strategies when prices moved between 90 and 120 dollars a barrel, but while they stayed within those limits it did not concern us. Volatility is volatility. However, when prices started moving between 30 and 60 dollars, even a 2-3 dollar difference can be painful.

Mr. Kurdin, what key events at the oil market are expected to happen this year?

Mr. Kurdin: In the first half of the year Iran will increase its exports, and the question is how fast they can restore their oil industry after sanctions. This will determine the amount of overstock at the global market.

If they increase their supplies by one million barrels a day, then in the course of 2016, we cannot expect the world reserves to go down in any significant way. This means that the fundamental pressure keeping prices down will not be released until mid-2017. If for some reason Iran cannot restore its production capacity, then the prices will rebound earlier.

Can OPEC bring any good news?

Mr. Kurdin: I doubt it. OPEC has given up trying to do anything (in December they made no decisions on oil quotas at all. - Editor’s note). Still, they may come up with some decisions at the meeting on 2nd June.

We will need to see how the macroeconomic situation develops in China, which is one of the main demand drivers. Their December figures for industrial production were quite optimistic, and their export trade date release in January similarly so. However, the drop in the Chinese stock exchange points to instability. If pessimistic forecasts in relation to Chinese economy are not justified, this may give a positive push to the oil market, but it will not change the situation radically.

It takes something really big to change the oil market tendencies, something to do with demand. It could be the events in the Middle East around the Islamic State, or Iran having major problems restoring its production capacity, or some environmental disaster, god forbid, or infrastructure difficulties, - in short, these type of things you cannot bargain on.

What about American oil supply?

Mr. Kurdin: If prices keep at their current level, the US will have to cut production by half a million barrels a day compared to 2015.

What ‘forks’ are in store for oil and gas companies this year?

Mr. Kurdin: Gas has a number of possible political ‘forks’. As far as oil is concerned, I do not see any significant forks in foreign policy.

Can the Europeans who are trying to lower their dependance on Russian fuel use the lifting of American oil export bans to this end?

Mr. Kurdin: This is a serious issue in relation to gas, but not oil, which you can export from wherever you like - Africa, Middle East, Canada - take your pick.

It is the fiscal decisions of the Government that are going to play a major role for the oil companies this year?

Mr. Kurdin: True. The budget situation being difficult the tax burden on the oil and gas industry increases. You cannot ignore that, because you need to find money somewhere. I believe in the future, the priority will be given to the stable taxation. Yet, we cannot exclude the possibility of new amendments to the taxation system.

Source: Rossiyskaya Gazeta