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Aleksandr Novak: Forecasting is unrewarding business

June 01, 8:00 UTC+3

Russia’s energy minister in TASS special project Top Officials

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3 pages in this article
© Stoyan Vasev/TASS

On oil production freezes, shale reserves, freeloaders and bonuses

—  Are congratulations still pouring in for the extension of the OPEC agreement on output cuts?

The second try to clinch a deal was far easier, because we already had a record of previous joint work with our foreign partners to rely on. Besides, the market remains off balance, so the decision in favor of the extension that was adopted in Vienna on May 25 was a well expected one. The talks revolved mostly around the prolongation period and the volumes. Various options were considered: six, nine or twelve months. In the end, we managed to achieve unanimity.

— The joint statement you made together with your Saudi counterpart Khalid Al-Falih in Beijing on May 14 was a great surprise to many. As a result, Brent Crude prices instantly climbed 1.5%.

We had plans in advance for a meeting on the sidelines of the One Belt and One Road forum. We agreed to hold talks there on ways of stabilizing the oil market. Before Vienna, we were to get in touch with representatives of other countries and to persuade them to support our initiative.

We had maintained contact with Mr. Al-Falih and his team before Beijing. We held a meeting during the holidays in early May…

— In whose territory was that?

Let us put it this way, it was a neutral venue in the Middle East. A reasonable, appropriate and well-coordinated decision was to be proposed to the market. Had we gathered in Vienna each sticking to one’s own stance, we would’ve been hopelessly bogged down in a prolonged debate, ending up empty-handed. So we had been gearing up for the Beijing meeting beforehand, and of course our president provided great support.

But first a consensus was to be achieved at home and positions adjusted and verified. Consultations with the heads of the country’s largest companies were conducted.

A variety of possibilities was looked at. At the first stage, it was stipulated that an agreement to cut output might be prolonged for six months. That’s what was agreed on in Vienna in December 2016. Given the current realities, though, it would’ve suited nobody, because the agreement would have to have been abandoned during the winter, when demand usually suffers the worst slump. During this time of the year, demand usually stands at one and a half to two million barrels below that of the summer season. Had a large amount of crude emerged on the market at that particular moment, a collapse would have been imminent, with the risk of oil prices plummeting below $30 per barrel.

There was unity that the deal should be prolonged at least for nine months. Everybody, including our Saudi partners, agreed. We managed to persuade them that it would make no sense at all to prolong the deal for a shorter period. Otherwise, we would begin to be asked in a month’s time what would happen next, right after New Year’s. Such uncertainty is no good for the market.

The strategic task is to cause world oil stocks to shrink to a five-year average. That’s approximately three billion barrels.

During the crisis, stocks of crude oil climbed to 3.3 billion barrels. This surplus is to be cut by all means. Demand is already above supply today. During the time that the agreement has been in effect, oil stockpiles dwindled by about 70 million barrels. With that in mind, we should keep moving on in this direction.

According to our estimates, crude stocks will be down by a hundred million barrels by July 1. In the second half of 2017 and the first quarter of 2018, oil stocks will fall by another 200 million.

— What about the shale oil factor?

This risk is not so great as it might seem to many. The situation is to be looked at in the long term and comprehensively. We operate in a market environment, aren’t we, and shale oil is just one of the many sources of meeting the demand. The demand for oil keeps growing. This year it ups approximately 1.3 million barrels a day, and a 1.2-million-barrel growth is expected next year. Analysts say the growth in demand in the next 10-15 years will be no smaller than a million barrels a year.

It is obvious that shale oil will be unable to satisfy the increasing demand. Take a look at a sprinter running the 100-meter dash.
First, there is a rapid acceleration, then, a stable speed has to be maintained during the better part of the distance so as to not fall behind.  Shale oil production got off to a quick start. By now it has almost achieved the cruise speed phase, if you wish. To maintain production at the current level considerable efforts will have to be exerted – more investment, more reserves, more fields… I believe that shale oil production will remain in the acceleration phase this year and next year, while by 2019-2020 it will be very hard to keep up maintaining the original pace.
Shale oil today accounts for 6.5 million barrels of the total 95 million barrels produced daily around the world. Even if its production rose to nine million or even 10 million barrels a day, nothing tragic for the market would happen.

In the meantime, there are far greater problems to tackle. Production at traditional deposits has been declining by four percent on the average year in year out. Last year’s surplus of newly-explored reserves was the lowest in 70 years – just 2.4 billion barrels. Earlier, in 2001-2015 the annual growth averaged 9 billion barrels. Investment into the industry slumped by half a trillion dollars over the past three years and the number of final investment decisions on oil projects is also at a several decades’ record-low. This poses considerable risks to the stability of energy supply in the future. In fact, this explains why we sought to achieve joint concerted action in Qatar back last spring.

— That first attempt was aborted. In April 2016, the agreement to cut outputs remained unsigned, although the odds had looked quite favorable. You set off for Doha in a rather cheerful mood, but then…

Quite right. First, we made rapid headway in the right direction. A minister-level meeting in February showed that four countries, including the two largest world exporters of crude – Saudi Arabia and Russia - and also Qatar and Venezuela, were close to concluding an agreement to freeze production growth. The issue on the agenda was only a freeze, nothing more than that. At that time, such a step would have been enough for crude surplus to leave the market and the situation to regain stability.

 

Let me say once again, our task is not to mechanically raise prices

Let me say once again, our task is not to mechanically raise prices. We are to keep the market in balance. Prices are a derivative. In the autumn of 2016, oil was trading at $27 per barrel, but it may well have slumped to $15. This is not exactly what one would call a fair price, though. Oil market profiteers deliberately went bearish and opened many short positions. Far more than usual, as their aim was to push prices down as low as possible with the goal of eventually skimming off the cream. Naturally, this could not go on indefinitely. Prices would surely bounce back sooner or later, but still not significantly enough from the standpoint of the investment process and future supply. At least, in the context of existing production costs and the need for satisfying current requirements and future supply.

What was the meaning of the proposed freeze deal? It provided guarantees for certain stability and clarity as to what market participants might expect in the future. This type of understanding is extremely important for making decisions in the long term. When prices fluctuate (today they may soar and tomorrow plummet), uncertainty breeds chaos and leaves no opportunities for strategic planning.

In Qatar, in February the four countries agreed to everything in principle and decided to conduct a preparatory meeting with the other participants within six weeks’ time. Delegates from 18 countries – 11 OPEC members and seven non-affiliates - gathered in Doha in April. A memorandum slated for adoption had been drafted beforehand. On April 16, literally on the eve of the meeting, the experts finalized its wording.

Everybody was certain that the memo would be signed the next day - a sheer formality. Regrettably, one of our partners changed his mind at the very last minute, which came as an utter surprise to many others.

The lack of consensus played a bad role and no agreement was concluded

 

— Then it looked like another try would never follow. That the declared goal was unachievable.

We realized that the issue would have to be tackled sooner or later. There was no escaping it. Prices remained volatile and investment was dwindling. A dialogue was resumed with the newly appointed Saudi minister, Al-Falih. We began discussing a future deal and its framework in detail.

— When did you meet for the first time?

First, we held some informal meetings, off the record. The government ministers concerned were to arrive in Algeria for an annual energy forum at the end of September 2016. We agreed to discuss further steps in a broad format, for which a large amount of homework had to be done. In early September, Mr. Al-Falih and I met on the sidelines of the G20 summit. We inked a joint statement on cooperation between the two ministries and on coordinating market policies. It was a crucial sign for everybody else: Russia and Saudi Arabia had returned to the negotiating table. Our countries are the market’s key players. It sent a clear message to everybody else. Russia was then in talks with those oil producing countries it had been on friendly terms historically: Azerbaijan, Kazakhstan, Mexico and Iran… Disagreements between certain countries remained. We were very keen to help them narrow their differences. We met each other very often during that period, literally every week.

We realized that the issue would have to be tackled sooner or later. There was no escaping it. Prices remained volatile and investment was dwindling. A dialogue was resumed with the newly appointed Saudi minister, Al-Falih. We began discussing a future deal and its framework in detail.

— Khalid Al-Falih said he was going to accept your invitation to visit the Arctic and Siberia. Where will you take your guest?

To begin with we decided to show him around the newly-built LNG plant in the north of the Yamal Peninsula. This is a unique project being implemented in the harsh Arctic climate.

Last October, we traveled to Saudi Arabia, where we had a tour of various facilities, including offshore rigs in the Persian Gulf. Now it is our turn to welcome guests. I do hope that this summer Al-Falih will be able to see for himself some places where oil is produced in Western and Eastern Siberia: Talakan, Vankor, and Surgut…

— Will it be just a sightseeing trip or do you hope to make the Saudis interested in some specific projects?

We are hoping to cooperate in the future. A joint working group has been created for that. Saudi Arabia runs several full-fledged research centers focused on oil refining.

— It goes without saying that Russia’s decision to cut outputs was a political one. But in what way were the 300,000 barrels distributed inside the country? There were hardly any volunteers ready to make such sacrifices.

 

The approach was simple. Naturally, no oil producer was eager to assume any extra burden that the production cuts would entail. At a meeting with the heads of 12 oil majors it was agreed that each of them would their adjust production plans starting from October 2016 by an amount proportionate to their share in the overall national production. In other words, the companies agreed to assume proportional obligations. The pattern was fair and transparent. Of course, everybody keeps an eye on one another to be sure the voluntary pledges are complied with and there are no cheaters or freeloaders.

 

— And who was the hardest-hit in real terms?

I would avoid using the verb “hit”, because all of our companies have felt the positive effects of this deal. Lower outputs and compensation obtained as a result of price hikes unequivocally work for the government budget, the economy, and, consequently, for the companies themselves. Let me say once again: stabilization benefits all.

— Will quotas inside the country undergo any change now that the agreement has been prolonged?

No, the burden’s distribution will remain at the previous level. It is proportionate to outputs. This formula is the fairest of all. True, each company has certain nuances. Some had been building up production and now had to make more significant cuts. Others, on the contrary, had had the intention to keep production unchanged or even reduce outputs. The latter found it easier to join the process.

As far as specific statistics is concerned, it is common knowledge that Russia’s largest oil company is Rosneft. It accounts for about 40% of the country’s oil production. Other companies’ parameters are lower, but all of them stick to their reduction pledges. We monitor this. The Energy Ministry holds daily meetings with the oil companies’ representatives. It is noteworthy that the pattern works without any special instructions issued. We, a government ministry, support this measure, but it was a voluntary choice of the companies concerned.

— What if somebody breaks the rules? Do you have any leverage at hand to call the abusers to order?

There can be no such leverage. It is not a cartel deal, but an independent decision by individual market participants.

— Have you gauged the economic effects of the decision to prolong the output cuts deal?

We entered into negotiations last year. The barrel’s price jumped to $50-$60 on expectations.

But for the agreement signed late last year and prolonged this year, the price would have certainly sunk to below 40 dpb. The gain our joint measures earned us is approximately 15-20 dpb on one barrel of crude. My arithmetic tells me this: Russia produces 11 million barrels a day. That’s an extra revenue of no less than $110 million. Clearly, the amount is distributed among the federal budget and the companies, but the bulk of these incomes goes to the treasury, because we have progressive taxation: the higher the price, the greater the deductions.

The prices as they are, Russia’s budget this year is to receive a surplus of one trillion rubles in contrast to the expected target. The monthly surplus from January to May is one hundred billion. As you may know, the budget is undergoing an upward adjustment.

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