Why Russian oil companies are not in danger of oil collapse

US, WASHINGTON (ORDO NEWS) — Two weeks have passed since Igor Sechin achieved the severance of the oil production pact between Russia and Saudi Arabia, provoking a price war, because of which the value of his company fell by 40%. But the boss of Rosneft does not repent of anything.

“There is no need to dramatize these things,” said a close ally of President Vladimir Putin, who heads Russia’s main state-owned oil company. – It sways. But what consequences will this have? The [oil] market will adjust.”

Demand for oil is falling due to the coronavirus pandemic, as cities are quarantined, plants are closed, and planes do not fly. Due to increased production in Russia and Saudi Arabia, which are fighting for buyers, oil prices have fallen more than two times in three weeks, and now for the first time since 2003, a barrel costs $ 25.

Sechin believes that by extracting more oil, Russia makes life difficult for competitors, and this helps it expand its market share. At least in the short term, he has reason for such confidence.

The largest oil companies in Russia have every chance of withstanding a drop in oil prices in the next two years, taking into account the advantages that they have over foreign competitors. Production will bring them profit, even if prices drop to $ 15 per barrel.

“Russia is no worse, or even better, than Saudi Arabia ready to continue this price war,” said analyst Amrita Sen of Energy Aspects.

Such resilience of Russian companies amid falling prices is partly the result of American and European attempts to harm them.

For six years, under conditions of Western sanctions, they have limited access to Western technology and capital. Therefore, most of the costs and debts in them are in rubles, and not in dollars.

Another plus is the free floating rate of the Russian ruble, in contrast to the Saudi rial and UAE dirham, which are tied to the US dollar. When oil prices fall, the ruble as a whole weakens, and therefore, ruble export earnings increase.

And in Russia there is a taxation system that reduces taxes on producers in case of falling oil prices. Moreover, the country’s oil companies in recent years have created large foreign exchange reserves.

“As soon as sanctions were introduced against Russia, the government and companies began to prepare for a recession,” said oil analyst Mitchell Jennings, who works in Moscow for Sova Capital, an investment company. “Most companies probably did not expect such a serious drop in oil prices, but today not one of the leading Russian oil companies is turning to the state for help.”

When oil prices are high in Russia, it is not the companies, but the state treasury that benefit most. When prices collapse, the picture changes exactly the opposite, because mining companies are exempted from taxes when Urals brand prices fall below $ 15. Prices for this Russian brand are usually five dollars lower than for Brent.

According to Alexander Burgansky, an oil and gas analyst at Renaissance Capital, such a system was created so that when prices fall below $ 25 per barrel, “the industry will switch to a self-preservation regime.”

According to the Burgansky model, if the ruble falls below 100 per dollar, and the Brent brand costs $ 15, Rosneft and the private company Lukoil will still have net profit before taxes. At a price of $ 10 per barrel, even small producing companies can pay dividends to shareholders.

According to Rosneft, last year its production cost averaged 199 rubles per barrel, and processing 202 rubles. As a result, the total amount of expenses was approximately five dollars.

Many other oil companies have much higher costs. In the North Sea, about a quarter of all deposits begin to operate at a loss when a barrel costs less than $ 30, according to Wood Mackenzie.

At such a price, Canadian oil production in oil sands, American shale production and deep-sea drilling projects off the coast of West Africa will also be in a vulnerable position.

But the question is how much Russia and Saudi Arabia will increase supplies in the near future. The fall in demand due to coronavirus (which is estimated at about a quarter of global consumption) will lead to the fact that in the near future no one wants to buy additional barrels.

And while Russian oil companies feel relatively comfortable, they have well-founded fears for the longer term.

Oil and gas sales account for approximately 40% of revenues to the state budget. The Kremlin claims that it will last for six years in the face of a fall in prices. But during previous price collapses, Moscow increased taxes for manufacturers, trying to get more money from them. This week, Putin announced the introduction of new taxes on bank deposits in order to finance incentive measures in a pandemic.

Price wars may also affect future mining. Most of the oil production is carried out in the fields of the Soviet era. And these are old deposits, and in order to maintain production volumes, large investments must be made in them.

If low oil prices continue for several years, this will lead to a reduction in investment. Then the decline in production will begin in old fields, which already work at maximum capacity.

Government officials say Russia can increase production by 300 barrels per day in a matter of weeks, and by a further 200,000 barrels over a longer period. The lion’s share of this increase will come from Rosneft. Saudi Arabia has promised to increase deliveries by 2.5 million barrels per day, and then another one million before it reaches the peak of its capabilities.

Other Russian oil companies do not agree with Sechin’s aggressive approach. Nail Maganov, who heads Tatneft, the fifth largest oil producer, said this week that “it will be difficult” to increase production. Lukoil already plans to reduce investments by one and a half billion dollars.

Last year, Russian oil companies gave the green light to new projects totaling $ 33 billion. However, Audun Martinsen, a partner at Rystad Energy, expects this figure to drop to $ 10-15 billion from 2020-2021.

“They will try to save on capital investments in order to protect profits, and the best way to do this is to cancel the development of new deposits,” he said.

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The article is written and prepared by our foreign editors from different countries around the world – material edited and published by Ordo News staff in our US newsroom press.