Friday, February 14, 2020

The Coronavirus May Mark The End Of Russia-OPEC Cooperation

Chinatopix, via Associated Press

A week ago, at an emergency meeting of the OPEC’s Joint Technical Committee, Russia refused to agree to the cartel’s proposal to reduce production by an additional 600 000 barrels per day (bpd). Explaining Russia’s position, Energy Minister Alexander Novak said that in order to make such a decision, it takes time to evaluate the effect of coronavirus on the oil market.

It is really not yet clear how much the coronavirus will reduce global demand for crude oil. In February, amid the unfolding epidemic, OPEC lowered its demand growth forecast for 2020 by 230 000 bpd to 0.99 million bpd. The Oxford Institute for Energy Studies is more pessimistic: according to its estimates, in China alone, demand in Q1 2020 will decrease by at least 500 000 bpd. Russian Energy Minister Novak, on the other hand, retains moderate optimism, believing that the global decline will not exceed 200 000 bpd.
An Elusive Asian Market

However, even if the coronavirus turns out to cause more damage than the most pessimistic estimates, Russia should still not further reduce its oil production - on the contrary, it’s time to start preparing for a phased exit from the OPEC+ deal. This is first of all, due to increasing competition in the Asian market, where Russian companies have redirected exports in recent years. According to BP, from 2016 to 2018, Russia reduced oil supplies to Europe by 14 percent (from 177.4 million to 153.3 million tons), while increasing exports to China and India by more than a third (from 52.8 million to 73.8 million tons). A similar strategy was employed by Saudi Arabia, which over the same period managed to compensate for the reduction in supplies to Europe (by 1.7 million tons) with their total increase to India and China (by 4.7 million tons). The same applies to the United States, which last year reduced its exports to China by more than twice their original value due to trade war (5.8 million tons compared to 12.6 million tons in 2018, according to Refinitiv). In the next couple of years, the U.S. will inevitably increase exports, as a result of the Phase 1 trade deal, in which China pledged to purchase $52.4 billion worth of oil, liquefied natural gas (LNG), and other energy products from the United States by the end of 2021.  

The increasing competition will complicate entry into Asian markets for Russian companies that intend to monetize East Siberian oil reserves through exports. This is not only the Kuyumbinskoye field of Gazprom Neft and the Yurubcheno-Tokhomskoye field of Rosneft, but also the Lodochnoye, Tagulskoye, Vankorskoye and Payakhskoye fields, which are the basis of the Vostok Oil project, which in itself is worth 10 trillion rubles (over $157 billion), which will increase Russian GDP by 2% annually, according to the estimates of Rosneft CEO Igor Sechin. The increase in production at these fields will inevitably lead to non-compliance with the OPEC+ output cut deal, which the cartel hopes will keep oil prices above $60 per barrel. However, such a price level is disadvantageous for the Chinese and Indian economies, which in 2019 showed the lowest growth rates over the past 30 and 11 years, respectively (6.2% and 4.8%), according to data from IHS Markit. This, in turn, slows down oil demand - the International Energy Agency predicted a quarterly decline for China back in December (from 13.84 million bpd in Q4 2019 to 13.53 million bpd in Q1 2020), when the coronavirus had not yet affected the commodity markets.

The US Market: A Dangerous Alternative
In this regard, the fall in oil prices will certainly spur demand in India and China, and may therefore be beneficial for Russia, for which the Asian market is the only reliable alternative to supplies to Europe. The American market can hardly claim the role of being such an alternative in the long run, even if in 2019, Russia entered the top three largest suppliers of oil and petroleum products to the United States, increasing exports from 9.9 million bpd in January to 20.9 million bpd in October, according to the US Energy Information Administration (EIA). This jump in exports can be credited to the U.S. sanctions on Venezuela, which since July 2019 has not delivered a single barrel of oil or petroleum products to the United States. The same applies to Iran, whose crude exports fell from 1.2 million bpd in January 2019 to 0.1 million bpd in January 2020, according to Refinitiv.

If the geopolitical situation changes, traditional suppliers will surely return to the American market (which is a risk for Russian companies), and at the same time they will face a decrease in US dependence on commodity imports. In reality, this is already happening: in September, American exports of oil and petroleum products exceeded imports for the first time since 1973, when statistical observations began. In November, net exports (exports minus imports) reached 771 000 bpd in the United States - in 2020 it will increase to 790 000 bpd, according to the February forecast by the EIA, and in 2021 this number is expected go up to 1.16 million bpd. It is likely that the actual figures will exceed forecasts, as consolidation has already begun in the American shale industry, which will in turn contribute to its financial recovery. This is evidenced not only by the acquisition of Anadarko by Occidental ($57 billion), which agreed to take over the debt of its former competitor, but also by the recent transactions between relatively small oil-producing companies in the Permian basin - Callon and Carrizo ($2.74 billion), WPX and Felix ($2.50 billion), as well as Parsley and Jagged Peak ($2.27 billion). 

Coronavirus as a Catalyst for Change

Improving financial stability will not only support the growth of oil production, but also future exports. Besides consolidation in the shale patch, increasing investment in the U.S. Gulf Coast export facilities is expected to boost exports to 8.4 million bpd by 2024, according to last year’s IEA forecast. This will help the United States come closer to Russia and Saudi Arabia in terms of export volume (5.5 million and 7.2 million bpd, according to the BP data for 2018). For OPEC and Russia, it is better to prepare for such a turn ahead of time than to wait for the moment when the policy of reducing production will finally lose its economic meaning. In this context, the coronavirus is just a catalyst for processes that have been taking place in the market for a long time. It is self-evident for Russia that it should move towards a phased exit from the OPEC+ deal in order to prevent losing market share to its competitors.

For OPEC, this is nothing new. It has seen its share in global oil production fall from 38.6 percent in Q4 2016 (when the first OPEC + agreement was signed) to 34.1 percent in Q4 2019, according to Refinitiv, while the share of OECD countries grew from 27.6 percent to 32.4 percent. A further decrease in market share will inevitably reduce the cartel's influence on oil prices. Therefore, it is reasonable for Russia to shift the responsibility for reducing oil production entirely to Saudi Arabia, which, within the framework of existing agreements, can expand its own quota for reducing production by 400 000 bpd (up to 900 000 bpd to the level of October 2018).

Such a decision could be a first step towards a gradual suspension of the agreements, which will allow Russia to compete in the global oil market, and not just remain a passive witness.

By Dr. Fares Kilzie for

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