An Opportunity for Russian Oil?

Some producers want Putin to square off with OPEC

In one corner: Saudi Arabia, the world's top oil producer and leader of OPEC. In the other: ever-combative Russia, the No. 2 producer. With Russia refusing to heed recent OPEC demands to join in big production cuts, the sparring could escalate into an all-out price war. Lower oil prices could aid consuming nations, including the U.S., but damage the economies of the producers. The prime question in this test of nerves: Who will blink first?

Right now it's a hard stare on both sides. With 61% of the world export market, OPEC members at their Nov. 14 meeting in Vienna declared a willingness to slash production by 1.5 million barrels a day to get the price of OPEC's market basket of crude back up to $22 to $28 per barrel. That price, as high as $34 a barrel 14 months ago, fell below $16 before rebounding slightly on Nov. 20. But if producers don't come to terms, prices could go as low as $10 a barrel.

To protect its market share, however, OPEC said it will implement the cut only if Russia and other non-OPEC countries cut output by 500,000 barrels a day. Russia's response was an offer by Prime Minister Mikhail Kasyanov to trim production by 30,000 barrels a day. In other words, nyet. The insult hit its mark. "Russia's cut is minuscule and disappointing, and we don't take it seriously," says Saudi Oil Minister Ali Naimi, whose country has cut output by over 2.5 million barrels a day. Other big, non-OPEC producers such as Norway and Mexico have agreed to make production cuts. But Russia is sticking to its position.

Both Russia and Saudi Arabia have plenty to lose if prices spiral down. Rising oil prices have been the leading contributor to Russia's rebound after its August, 1998, financial crisis. Russia's domestic debt is only 2% of gross domestic product, vs. 18% before the crisis. Nevertheless, every $1 drop in the price of crude costs Russia about 0.3% in GDP, $2 billion in export revenues, and $1 billion in federal revenues.

"DISASTER." The country could tolerate oil prices of $15 a barrel. At that level, however, annual GDP growth, pumped up to 5.5% by high oil prices for most of the year, would drop to 1.6%, according to an analysis by Moscow-based Alfa Bank. "Ten dollars per barrel would be a major disaster for Russia," says Steven Dashevsky, an oil analyst at Capital Group Aton in Moscow.

Saudi Arabia, which has much cheaper production costs, would seem better positioned. But its overall economy is much more dependent on oil. Over 90% of the Saudis' total export revenues come from oil, compared with just 25% for Russia. Oil exports sustain every important government project, from the building of hospitals to the laying of roads. And despite its oil wealth, Saudi Arabia has a 15% unemployment rate and a rapidly growing workforce. If oil drops to $10 a barrel, the economy could slip into a destablizing recession. Some in Russia are betting that the prospect of political unrest will push the Saudis to give in first on production cuts.

Perhaps. But the Russian oil industry, now in private hands and notorious for its internecine warfare, is hardly speaking with one voice. Sounding the bugle for an all-out battle with OPEC is Russia's second-largest producer, Yukos, which this year has increased production by nearly 18%. Yukos argues that the dispute offers a golden opportunity to grab share and establish Russia as a safe and reliable alternative to OPEC.

But No. 1 producer Lukoil says Russia should try to reach a compromise with OPEC. It makes no sense to attempt to grab market share by a production hike, says Lukoil Vice-President Leonid Fedun, because Saudi Arabia can more cheaply match any such increases. "I don't think for the success of one company, all the other Russian oil companies and the Russian budget should pay," says Fedun. But in fact, Lukoil does not have the rest of Russian oil on its side. Sibneft, Russia's sixth-largest oil producer, is vowing to stick with plans to increase its output by 18% in 2002.

Ultimately, it will be up to Putin to determine Russia's position. The Kremlin can't order companies to slash output. Nevertheless, Putin is enormously popular and controls tax policy and other instruments of importance to the oil industry. So Russian producers, including Yukos, agree that it would take but one word from the President to persuade them to fall in line. With his bid for closer ties with the West, Putin might be tempted to go along with Yukos. But if oil prices continue their precipitous fall, economic pressures at home may force him to rethink the virtues of trying to please everyone.

By Paul Starobin in Moscow

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