Putin's Reward for Doing a Deal With OPEC Overshadowed by Risks

  • Reducing flow of Russian crude could damage fields, pipelines
  • Russia, Saudi Arabia, Qatar, Venezuela agree oil-output freeze

Can U.S. Oil Capitalize on Russia, Saudi Output Freeze?

Neither a recession nor a collapse in revenue has been enough to convince Russian President Vladimir Putin that it’s time to join with OPEC and cut oil output to boost prices. His reasons may be pragmatic rather than political.

Russia’s Energy Minister Alexander Novak and his Saudi Arabian, Venezuelan and Qatari counterparts came to a preliminary agreement on Tuesday to freeze output at January levels. The world’s second-largest crude producer faces numerous obstacles to any deal that would actually cut production, even if Putin decides it’s in the national interest. Reducing the flow of crude might damage Russia’s fields and pipelines, require expensive new storage tanks or simply take too long.

Prior to Tuesday’s agreement, Novak had said he could consider reductions if other producers joined in. Yet Igor Sechin, chief executive officer of the country’s largest oil company Rosneft OJSC and a close Putin ally, has resisted, saying last week in London that coordination would be difficult because no major producer seems willing to pare output.

“The history of relations with OPEC suggests that Russian companies are not keen to cut production,” James Henderson, an oil and gas industry analyst at the Oxford Institute for Energy Studies, said by phone. “There are certain practical difficulties, and the companies would rather somebody else did that, and they could benefit once the price goes up.”

Brent crude, the international benchmark, rose as much as 6.5 percent as the four producers held closed-door talks in Doha. Prices dropped after Saudi Arabia’s Oil Minister Ali Al-Naimi said freezing output at January levels will be “adequate” and the nation still wants to meet the demand of its customers. Futures were down 2 percent to $32.72 a barrel at 3:45 p.m. in London.

QuickTake Oil Prices

Frozen Pipelines

In Siberia, Russia’s main oil province, winter temperatures can go below minus 40 degrees Celsius (minus 40 Fahrenheit). That’s a challenge for anyone thinking of turning off the taps.

The oil and gas that flows from wells always contains water, so once pumping stops, pipes may freeze, Mikhail Pshenitsyn, who has worked for more than 10 years in the Russian oil industry, said by e-mail. The problem goes away in summer, but there’s still the risk of a long-term reduction in output because a halted reservoir can become polluted with salts and residues, he said.

Production from a shut-in well might never be restored in full, Maxim Nechaev, director for Russia at consulting firm IHS Inc., said by phone.

Russia, however, sees no difficulty committing to stable production as higher taxes introduced at the beginning of the year dampen the investment potential in the country’s upstream segment, Deputy Prime Minister Arkady Dvorkovich said Tuesday.

“It’s not very hard for us overall to take on this obligation,” Dvorkovich told reporters in Budyonnovsk, a city in southern Russia. “At present, we’ve had to raise taxes and just from the financial point of view that won’t allow for production growth,” he said, adding that a deal with other oil-producing countries won’t require any additional agreements with Russian companies.

Russia could reduce exports to global markets without cutting production simply by putting more crude into long-term storage. Trouble is, the country has too few facilities.

The bulk of onshore storage capacity in Russia is owned by pipeline company AK Transneft OAO and already in full use to ensure steady flows to refineries and ports, Vladimir Feigin, head of the Moscow-based Institute for Energy and Finance, said by phone.

More Storage

Building the massive new reservoirs required to store a significant proportion of production for an extended period would cost billions of dollars and couldn’t be done quickly, he said.

While crude can be stored in vessels moored just offshore, Russia has "only seven tankers -- four products and three crude -- in floating storage,” Antonia Mitsana, marketing manager at London-based Drewry Maritime Advisors, said by e-mail. Their total capacity is just over 643,000 metric tons, according to Drewry, or about 0.1 percent of the nation’s production last year.

Chartering foreign vessels to store significantly more oil would be expensive. Freight rates are up in the short-term tanker market and ships in limited supply, Mitsana said.

Raising Taxes

Russia’s government is seeking ways to increase revenues from the energy industry, which generates more than 40 percent of the national budget. Finance Minister Anton Siluanov suggested cutting the price threshold for oil exempt from production taxes to $7.50 a barrel from $15, according to a report from RIA Novosti, a domestic news agency.

The measure could raise revenue by as much as 1.08 trillion rubles ($13 billion) if implemented at an average oil price of $30, according to estimates by Alexander Kornilov, an oil and gas analyst at Aton investment bank. That would help fill government coffers and could encourage companies to limit output at older wells with higher operating costs. Russia ran a budget deficit of 2.6 percent of gross domestic product in 2015, its highest in five years.

Yet changing the tax regime is a slower process than the “emergency” response Venezuela had been seeking.

“Usually such big tax changes would come into force from January of the next year" if they were included in the annual draft budget due in October, Sergei Likhachev, associate director for tax practice at Moscow-based law firm Goltsblat BLP, said by phone.

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