By Maria Shagina*
(FPRI) — A combination of a collapse in oil prices and the global pandemic has sent shockwaves through the oil industry. Compared to other oil-producing countries, Russia is better prepared to weather this oil price shock.
Since 2014, Russia’s economy has developed certain resilience, thanks to conservative monetary and fiscal policies. The large budget and foreign exchange reserves, a free-floating exchange rate and windfall taxation (the tax burden decreases with lower oil prices) help to cushion the impact. However, the double shock will take its toll on Russian energy majors’ profits and will have repercussions for the government’s budget revenues.
According to the Skolkovo Energy Centre, the overall losses will equate to 60% of export revenues and 30% of budget revenues. Depending the degree of compliance with the OPEC+ deal and the severity of lockdowns, these losses would result in an 8-12% drop in gross domestic product (GDP) and would be comparable to the total reserves of the National Wealth Fund (NWF).
Rosneft already incurred a $2.1 billion loss in the first quarter of 2020 and expects a 10% decline in oil output. Oil cuts and well conservation will be particularly painful for Rosneft, bound by long-term supply obligations under prepayment contracts with China. Many Russian brownfields are overflooded and after their shutdown, 50% may never resume production, making the decision about which wells to close especially challenging.
The global gas industry has been less affected so far, but the spillover from the oil industry is already evident. On May 29, gas spot prices fell below $33 per thousand cubic meters on the Dutch hub. As 60% of Gazprom’s contracts are linked to pricing on the European hubs, the company’s profitability will be threatened (its target is currently set at $100 per thousand cubic meters). To curb the fall in prices, Gazprom sought to cut its gas deliveries to Europe.
However, with the prices in Europe and Asia already heading to record lows and storage facilities reaching their operational limits, Gazprom’s position will be particularly damaged. Qatar’s recent announcement to supply additional liquefied natural gas (LNG) volumes to Europe will only exacerbate the situation. The spreading of the coronavirus on multiple sites, including the Chayandinskoye gas field, a key resource base for Gazprom’s Power of Siberia, and the Belokamenka yard, a manufacturing site for Novatek’s Arctic LNG-2, has put additional pressure on the companies to meet project deadlines.
The diminishing revenues from the energy sector will inevitably affect other adjacent industries, such as petrochemistry, metallurgy, and engineering. The ability of the energy sector, as the main revenue generator, to cross-subsidize non-commodity industries will decline. Unsurprisingly, some companies are already seeking opportunities to cling to lavish investments. For example, Russian Steel proposed that the government use only Russian-made pipes for the construction of the Amur Gas Chemical Complex, which was spared from SIBUR’s investment cuts plan.
Greater State Involvement
To shield its strategic industry, the Russian government proposed a number of measures. It exempted oil companies from any fines for their inability to maintain production targets. Larger oilfield services companies could be included in the list of systemically important companies, making them eligible for state support. Since 2016, the list also contains oil and gas majors.
To address the problem of well conservation, the government proposed to create a fund for unfinished wells to support oilfield services. With the help of state banks, Russian oil companies can continue well development and commission them after the demand recovers in 2022. Another measure included the creation of strategic storage of oil reserves, which would amount to 10% of Russia’s annual oil production.
Following international trends, the majority of Russian energy companies announced 20-30% capital expenditure cuts. To optimize their investment spending, companies are scrapping new capital-intense projects or lower-priority projects abroad. High-value-added sectors, such as LNG, oil refining, and petrochemistry, have gained momentum. Rosneft started lobbying for tax breaks for its hard-to-recover gas reserves in the Yamal-Nenets region. Tatneft announced it would reorient its investments to refineries, while Gazprom is planning the construction of a giant petrochemical plant in Yamal.
As Russian energy majors are forced to slash their investment expenditures, competition for state protection will only intensify, while the distribution of state funds will become more selective. Having no privileged access to state support, independent energy companies—the market’s share of which is already small (only 9%)—will suffer from the double shock the most.
Although the economic logic suggests deferring new projects, some Russian energy companies are driven by the market-share strategy. Despite the double shock, Russian companies have announced a number of ambitious projects. Rosneft launched drilling at Vostok Oil in the Arctic, while Gazprom started feasibility studies for Power of Siberia-2. Similarly, Novatek is not planning any cancellations and is considering the current environment as a perfect opportunity to capture growth in the LNG market in the second half of this decade.
Russia-China Asymmetric Relations Will Intensify
The COVID-19 pandemic will accelerate Russia’s dependence on China’s energy demand and financial support. As one of the first countries to emerge from the lockdown, China’s recovery will be crucial for Moscow to offset its budget losses and to finance its ambitious projects. With India in lockdown potentially until September, China remains the only option in the short term. Capitalizing on record-low oil prices, Beijing bought a record volume of Russian Urals crude oil in the first quarter of 2020. However, this recent import surge is sending a false positive to the market. It is projected that China’s energy demand will not fully recover, but only bounce back by 50%.
In the current low-price environment, financing Russia’s ambitious projects will be a particularly vulnerable issue. Moscow’s options for finding external financing will be thin, and its dependence on Beijing’s coffers will only intensify. The difficulties in raising capital could delay final investment decisions for Arctic LNG-2, which prior to the pandemic set to raise up to $11 billion on the external market. Other projects scheduled for 2021-2023, such as Gazprom’s Baltic LNG, will likely be shelved again. Tapping domestic reserves could be another, but more expensive, option. However, the government has seemed reticent to use savings from the NWF.
With China’s GDP growth dipping to a record low, the asymmetry in Russia-China relations will only be exacerbated. Even prior to COVID-19, China’s sluggish economy posed a threat to Russia’s own economic performance. As China is rethinking its post-COVID-19 energy strategy by placing emphasis on localized supply chains, Russia’s recovery could be particularly vulnerable. In its 2020 annual budget report, Beijing indicated that the country will seek opportunities to utilize its domestic production in order to lower the dependence on energy imports.
In the long term, the pandemic will have repercussions for hydrocarbon-dependent economies. Decarbonization strategies and climate change policies are getting more urgent in Russia’s key export markets. Governments and companies started altering their strategies by divesting from the fossil fuel sector.
The EU Green Deal seeks to increase the share of low-carbons, in particular that of the renewables. A number of Western commercial banks announced their plans to cease providing loans for Arctic oil and gas projects. If duly implemented, these decisions will have a serious impact on Russia’s export and budget revenues. Even prior to the pandemic, it was projected that due to the energy transition, Russian energy exports and budget revenues will decrease by 15% and 17%, respectively, by 2040. The pandemic will only exacerbate this dynamic and will put more strain on Russia’s commodity-oriented export economy.
With 40% of budget revenues coming from the energy sector, Russia’s Energy Strategy until 2035 emphasizes its traditional hydrocarbons and fails to address decarbonization and energy efficiency. The strategy of energy transition and the use of renewables are in their infancy. The drafted law On State Regulation of Greenhouse Gas Emissions, paradoxically, does not specify any greenhouse gas reduction or adaptation efforts.
Currently, it is the energy companies, not the government, that are leading the diversification policy. Driven by additional revenues rather than by climate change concerns, several Russian companies started looking into the market of renewables and hydrogen. RUSAL has implemented measures to cut greenhouse gas emissions. Gazprom and Rosatom announced plans to boost their hydrogen exports, with the main destination being Japan. In its energy outlook, Lukoil is promoting the application of carbon dioxide capture and storage technology. With more countries pushing for environmentally friendly renewables in a post-pandemic world, the Russian government will be forced to address the sensitive issue of hydrocarbons dependence and to conduct the painful reforms for diversification.
The views expressed in this article are those of the author alone and do not necessarily reflect the position of the Foreign Policy Research Institute, a non-partisan organization that seeks to publish well-argued, policy-oriented articles on American foreign policy and national security priorities.
*About the author: Dr. Maria Shagina is a CEES Postdoctoral Fellow at the Center for Eastern European Studies at the University of Zurich.
Source: This article was published by FPRI