Oil prices will not go up much above USD 40-50 a barrel

13 april 2016 | Rossiyskaya Gazeta

Alexander Kurdin, the Head of the Department for Strategic Studies in Energy of the Analytical Center, told Rossiyskaya Gazeta that the mere fact that the meeting in Doha was scheduled brought Russia billions of rubles in extra oil revenue as it kept the prices at USD 40 a barrel. Therefore we should meet more often, the expert says. The largest oil exporting nations are to meet and reach an agreement in Doha on April 17. Russia, Saudi Arabia, Venezuela and Qatar that had already agreed to refrain from increasing production are going to try and persuade about a dozen more countries to follow suit.

Alexander Kurdin
Alexander Kurdin
Department for Fuel and Energy Sector

Mr. Kurdin, and what is going to happen after April 17 if the expectations are not met? Remember all the hopes that were pinned on the OPEC meetings in 2014 and 2015 and what happened after those effectively ended in nothing.

Alexander Kurdin: A temporary shock is possible but the price is unlikely to fall below USD 30 a barrel. I cannot say the markets are expecting much from this meeting; in fact, the general attitude towards it is rather cautious.

And what if the meeting turns a success?

Alexander Kurdin: If the parties succeed at agreeing to freeze oil production, and if the trend towards lower production in the US continues, and if Iran does not expand production above the pre-sanctions levels, then the prices may begin to edge upwards. But, seeing the kind of difficult situation we have in the market at the moment, we cannot really expect them to rise above 40-50 dollars a barrel.

Would that be enough for Russia in terms of budget deficit?

Alexander Kurdin: No, of course, that would not be enough. A price of 50 dollars a barrel is pretty far from comfortable for the Russian Federation budget. And if the price remains at the current level of about 40 dollars, then in 2016 and 2017 we may see a budget deficit of 6 trillion rubles. The Reserve Fund can be tapped for 4 trillion, but once that money is gone, we will have run out of monetary reserves. This means we need to get an extra trillion from somewhere now or go looking for 2 trillion next year.

How representative of the oil market will the meeting in Doha be?

Alexander Kurdin: Generally speaking the participants comprise OPEC plus Russia. OPEC produces almost 40 million barrels a day and Russia produces over 10 million barrels so the meeting’s participants represent roughly half of the global oil production. If Iran does not show up, and it is not yet clear whether they will come, then representation will be somewhat lower. Iran can send representatives but decline to take part in the deal and just act as an observer.

What would be Iran’s role in that case?

Alexander Kurdin: Iran is creating problems that cost other oil exporters very much. Global demand for oil is expected to rise by a little more than a million barrels a day this year. As for the total supply, it is going to remain at the same level outside OPEC, except in the US. An earlier forecast of a fast decline in oil production in the US was coming to pass there in early 2016 and by the end of the year the US oil production will have fallen by 500 thousand barrels a day.

However, OPEC’s oil supply can increase by about a million barrels a day, primarily thanks to Iran. In the first three months of the year Iran already added 0.3-0.4 million barrels a day to the total OPEC production, roughly the same amount that US production declined by.

Thus, while last year the global glut of oil was over 1.5 million barrels now it has gone down to one million barrels.

And should we thank Iran for this extra one million?

Alexander Kurdin: OPEC as a whole but Iran in the first place. But for this increase in output, the current excess supply of oil would have disappeared by the end of the year. Furthermore, a shortage would most likely have appeared in the second half of the year and the prices would start going up.

Is Iran more interested in restoring its output than in higher prices?

Alexander Kurdin: Iran has not been hit nearly as hard by falling oil prices as the other OPEC members have; in 2014 it had a budget deficit of just 1% of GDP; in 2015 it went up to 3%, and in 2016 it will be below 2% if they step up production. The bulk of their problems have to do with the sanctions. So at this point it is impossible to demand that they refrain from expanding production once the sanctions are lifted. In the meantime, other oil exporting nations are looking at budget deficits of 10-15% of GDP while in Saudi Arabia it is nearing to 20% of GDP.

Are you saying they might actually need this agreement more than Russia, seeing how our budget deficit is much lower?

Alexander Kurdin: The thing is that the Saudis have a far larger sovereign fund than Russia and even with this sort of budget deficit it is going to last for a very long time... We are talking over 600 billion dollars there, in the meantime, we, with a mere 50 billion dollars in our Reserve Fund, do not really have many options. It would make more sense for the OPEC and Russia to buy up Iran’s increased output. Because the extra revenue these countries would be able to make if Iran froze its oil production would be much higher than the losses that Iran would incur by refraining from stepping up production.

In what way? How could it be done?

Alexander Kurdin: In whatever way would be acceptable, for example through direct financing, Iran could be given a loan... I am not saying there are any plans in the works to do that. I am just talking as an economist here.

Suppose Iran steps up its output by a million barrels a day. This would translate into 365 million barrels a year. At a price of 40 dollars, we are talking about 15 billion dollars a year. Of course, all the other exporting nations would lose much more than that. Take just the four countries that have agreed to freeze production so far: Saudi Arabia, Venezuela, Russia and Qatar: if the average annual price of oil went up from 40 to 50 dollars a barrel, with their total output of 28 million barrels a day they would get an extra revenue of USD 100 billion a year.

And could Russia agree to cut back production with the OPEC? I mean, if that is what it takes. And just leave Iran completely out of it.

Alexander Kurdin: On the one hand, in theory, it could be done. After all, we have got almost 50 million barrels a day, so even if you were to reduce production even by just a little like a couple percentage points... But there is a problem with collective action here. Because if everybody is twisting Iran’s arms, that is one story. But if every country has to cut back production by a very small amount then the big question is who would be controlling whom and how.

The countries that will not be coming to the Doha meeting, the ones that produce the other half of the total global output, why is it they are choosing to remain mere onlookers?

Alexander Kurdin: A lot of countries produce oil mostly for domestic consumption. For example, China is one of the largest oil producers in the world but it consumes all of it domestically. The US and the countries that get oil from the North Sea, they are all importers of oil. Their interests are completely different than those of the exporters.

As a net importer of oil, the US is more interested in low prices, despite having a huge oil production industry, aren’t’ they?

Alexander Kurdin: They want stable prices that are not too low. It goes without saying that the voters want cheap gasoline at the pump but a healthy oil industry that makes good money also means orders for manufacturers plus it is also among the top lobbyists that shell out good money for election campaigns.

In other words, if production was to be frozen and the prices returned to 50 dollars a barrel, the US would benefit from that too?

Alexander Kurdin: Yes.

And in technical terms, how can production be ‘frozen’? After all it is not just state-owned companies that produce oil in our countries

Alexander Kurdin: To start with, in the majority of the countries that are going to the Doha meeting oil is produced primarily by state companies and they will just do as they are told, no questions asked.

The situation in Russia is a bit different because even those companies that the state has a stake in are still formally private corporations. Take Rosneft, for example. BP owns a stake in it and it has got its own interests, which means they might not necessarily appreciate the situation. In addition, it has to be borne in mind that Russia plans to have Rosneft privatized and should the company start manipulating its output following orders from the Kremlin that would send all the wrong signals to investors.

But in this situation, negotiations would be possible. The number of oil companies is rather small and should an agreement be reached to freeze production, they could be offered some kind of compensation from the state, including some limited deregulation of the sector.

Plus, in theory, the state could fine-tune the taxes and fees that oil companies pay in such a way as to discourage them from increasing exports. Of course, some unexpected effects of such actions are also possible in the future. This means, the easiest approach would be to negotiate a provisional moratorium, including with major private companies.

Add to that the fact that it does not seem there are that many opportunities to expand production in Russia at the moment. Last year the sector set a record.

Alexander Kurdin: The past two years both economists and energy sector experts have been warning that we are practically at peak production. And yet, every year the record somehow gets broken. Last year, it was at least in part a result of the devaluation of the ruble, which allowed companies to cut costs somewhat. Another more important factor was the reduction of the export duty as part of the tax maneuver. This supported exports of crude oil and, consequently, production. This year no such drastic moves are planned, but growth within one percent is still possible.

Can we sacrifice that?

Alexander Kurdin: It is better to sell oil at a higher price later than to sell it cheap now. Because even in the worst case scenario we expect prices to start growing, if not this year, then next years for sure. So if we can limit production without mothballing any existing wells but simply by refraining from putting new capacity into operation, it would make perfect business sense for companies as well.

Isn’t all of this kind of reminiscent of the circumstances that the OPEC was originally set up under? Only now it is going to be OPEC plus Russia.

Alexander Kurdin: It is unlikely that an expanded oil production cartel like that could be established on a permanent basis. We are talking about creating a crisis mechanism to respond to price fluctuations. Russia has always pursued a sovereign policy in the oil market, seeing what a sensitive area it is.

And yet now it is willing to consider imposing restrictions on itself...

Alexander Kurdin: At the moment we are looking to join a provisional coalition on a temporary basis. We need it until the end of the year when the situation in the market is expected to improve. By contrast, OPEC members are obliged to meet on a regular basis and sometimes they make political decisions that do not necessarily have anything to do with the situation in the oil market. The most memorable example is the embargo on oil deliveries to countries that supported Israel in its conflict with Syria and Egypt in 1973.

Source: Rossiyskaya Gazeta