Putin’s oil deal is humiliating but inevitable

US, WASHINGTON (ORDO NEWS) — Leonid Fedun, the billionaire and major shareholder of Lukoil, compared Russia’s decision to sign the OPEC + deal with the signing of the Brest Peace Treaty in 1918, which allowed the country to leave the First World War. And both of these steps, in his opinion, were humiliating, but necessary. The alternative was significantly worse.

In early March, Russia, which had significant gold reserves and producers with a low production price, hoped to calmly survive the difficult period associated with the collapse of oil prices.

Having lost the opportunity to extend the deal with other oil exporters to reduce the current level of production, Moscow saw an opportunity to squeeze out from the market those participants whom it considers “free riders” – American shale producers who benefited from the restrictions of other producers and filled the markets with their crude flows oil.

But in the end, the reduction in oil demand due to the isolation regime caused by the coronavirus turned out to be too significant. The potential geopolitical benefits associated with the obvious participation in solving the problem, as well as losses in the event of obstacles, were very significant. Empty storage capacity was rapidly declining. Russia agreed to reduce production.

But the real challenge is yet to come. Saudi Arabia and Russia have announced that they will share the burden of reductions and reduce production by 5 million barrels per day from a baseline of 11 million.

This is half of the total reduction that the OPEC + group has agreed on (it included former OPEC members, as well as other manufacturers). At the same time, concessions from Moscow will mean much more significant technical risks, as well as future costs for Russian oil companies, which are forced to invent new methods to maintain mature fields in working condition. This means that the fulfillment of the terms of the transaction is associated with additional difficulties.

Russia could survive a longer period of extremely low prices. She has a special fund for a rainy day, designed just for such cases. However, President Vladimir Putin needed to alleviate the economic pain caused internally by the coronavirus pandemic, and therefore higher oil prices could help. He also hopes that participating in a deal that suits U.S. President Donald Trump could pay dividends in something else, such as sanctions. Unfortunately, those things that make sense at the virtual negotiating table are not always effective in practice.

To fulfill the terms of the deal in May and June, Russia needs to reduce production by 2.8 million barrels per day in relation to the reported level of crude oil production in March. According to experts at the Oxford Institute for Energy Studies, even with the exclusion of gas condensate, another 2 million barrels will remain, that is, a fifth of the total production of crude oil, which is twice as much as Russia can afford the assessment of Trafigura, a commodity trader, and Moscow called that amount. As a result, Russia will be forced to return to the volume of production, which was last recorded in 2003.

But the problem is not only a reduction in production. In fact, this is the easy part. The trouble is that about 80% of all oil is produced at mature Russian fields, and it is not so easy to stop and then restart them.

The reduction should not affect the ability of companies to restore the previous level of production and do it at a reasonable price. In addition, reductions should be made in such a way that the remainder of the production remains profitable. Kirill Tachennikov, an analyst with BCS Global Markets, believes that half of these companies do not have the technical equipment needed to quickly change production volumes. And there are other consequences associated with the level of local employment and changes in electricity consumption.

The question arises as to how the stipulated reductions will be distributed among Russian manufacturers, not all of which are under state control. Energy Minister Alexander Novak only said that Russian companies agreed on the need for radical measures, but so far there is very little information on how they will implement them.

Rosneft accounts for almost 40% of production in Russia, but its management can easily find reasons to abandon some restrictions due to the fact that part of its crude oil has already been pre-sold to China. Producers such as Tatneft, which have a significant number of mature fields, will suffer more.

There are some levers that Russian manufacturers can use. For example, they can direct more crude oil to more profitable refined products. Perhaps there is some room for maneuver regarding the conversion of official Russian data, presented in metric tons, into statistical indicators, expressed in the number of barrels per day. Vitaly Yermakov of the Oxford Institute for Energy Research indicates that many Russian producers, including those from Eastern Siberia and Sakhalin, produce lighter oil, which means that they get more barrels of their oil and therefore are able to make the process contractions are more manageable.

There is also a ray of light at the end of the tunnel – the temperature rises, and as a result, the process of changes at the facilities located in the northern latitudes will be facilitated.

A weaker ruble will also cut costs and possibly help protect future projects when their dollar value decreases. But even in the most favorable situation, it will be difficult for the OPEC + transaction participants to monitor the fulfillment of its conditions, especially when it comes to pipeline exports.

However, to avoid short-term pain, apparently, will not work.

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