Streetwise Professor reports:
Oil rallied [last] week (but still finished well below $50/bbl) primarily on reports that Russia would cooperate on output cuts with OPEC. Dmitri Medvedev has hinted that Russia might actually join the organization.
There are several reasons for skepticism. First, Russia has dramatically reduced its oil export duty, and is contemplating a further cut:
Russia cut oil export duties to $287 per tonne from November 1, from $372.2 in October, in response to calls by producers who feared making losses on overseas shipments. Russia’s senior energy official, Deputy Prime Minister Igor Sechin, had lobbied for an even lower November tariff of $195.20. RIA Novosti reported that Russia could reduce oil export duty to USD 117 per tonne to USD 119 per tonne from the current USD 192.1.
Mr Alexander Sakovich deputy head of the customs payments department at the ministry said the average price for Urals crude on world markets in the monitoring period from November 15 to December 9 inclusive was USD 44.5 per barrel. He said the price could continue to change until December 15 given high volatility on the market. Mr Sakovich said duty on light petroleum products could be cut to $91-$93 per ton against the current USD 141.8 and on heavy petroleum products to USD 49 per tonne to USD 50 per tonne from the current USD 76.4.
The Russian government decided to set export duties on oil and oil products on a monthly basis from December 1st and abandon the previously accepted bimonthly practice.
The most effective way for Russia to curtail oil exports (which is the only way it would have an impact on world prices) is to keep its export tax relatively high. Lowering the export tax encourages exports, and is contrary to statements that it will cut output. Sechin’s support for lower duties is especially important in this regard.
It is possible to both cut export duties and cut exports, but this would require the imposition of export quotas. Just keeping the taxes higher would be a more sensible and straightforward approach. Although higher export taxes would hurt Russian oil exporting companies–most importantly, Sechin’s Rosneft–this effect could be mitigated by some sort of compensation to these firms. (To work, though, this would require that the compensation not be linked to current exports or output in any way, as that would just offset the effect of the tax.)
The fundamental inconsistency between promising to cut output/exports in collaboration with OPEC on the one hand, and cutting oil export duties on the other makes me question the credibility of Russia’s statements. Moreover, formal monitoring and enforcement of members’ adherence to quotas within OPEC are doubtful enough, and informal promises from Moscow with no prospect of enforcement seem a very weak reed to lean on. Indeed, if I were OPEC I would be very leery of Russia’s representations. Russia has every incentive to encourage an OPEC output cut–and then to produce as much as possible to exploit the higher prices. If Medvedev and Putin think that attending the OPEC meeting and promising cooperation make it more likely that OPEC will indeed cut, they’ll do those things. The intent to adhere to those promises is highly doubtful, however.
Look at an atlas, and you will see that all of the members of OPEC sit within or very close to the Tropics.
That Siberia lies far to the north is one reason why Russian President Dmitry Medvedev’s hints about joining the oil group amount to mere posturing. The Organization of Petroleum Exporting Countries’ primary lever for influencing oil prices is raising or lowering members’ output — sometimes several times a year.
Try doing that when the Siberian winter freezes dormant wells closed, meaning they have to be drilled again. Meanwhile, summer thaws churn up the ground, bogging down maintenance equipment. In Russia, once you drill a well, it pays to keep it pumping.
In theory, the Kremlin could stockpile reserves to adjust export volumes. But this would take time and incur big costs in an economic crisis.
It also isn’t clear why Saudi Arabia, OPEC’s de facto leader, would want Russia to join the quota system. In 2007, the Saudis exported 7.9 million barrels a day, according to the U.S. Energy Information Administration. Russia exported seven million barrels. Saudi Arabia would risk seriously diluting its influence in an already fractious group. And for what? Does anyone think Moscow would abide by OPEC policies if it didn’t suit it?
In reality, Mr. Medvedev is dressing up Russia’s inevitable output decline — largely resulting from the state’s tightened grip on the energy sector — as a planned move co-ordinated with OPEC. Second, with the economy still a leveraged play on energy prices, and a possibly destabilizing ruble devaluation on the horizon, he is trying to talk up the oil market.
Far from hinting at increased Russian influence, the president’s words carry more than a hint of desperation.
Denning’s point about the inherently less flexible nature of Russian oil production is of great interest. It means that actual Russian cuts in the short run are more credible in the longer run than cuts in, say, Kuwait. Kuwait can cut today, and increase output relatively easily in the near future. If Russia cuts today, it is effectively committing itself to cut for a considerably longer period. Knowing this, it is less likely that Russia will choose to cut. It would be in a real jam if it cut in conjunction with OPEC, only to have the latter’s members (predictably) renege on their commitments weeks later. In that case, Russia would have the worst of all worlds–lower output and low prices.
So, I concur with Denning’s basic argument that Medvedev is just talking his book (as traders say), and that he is trying to get some price action in exchange for cheap talk.
Rather than listening to Medvedev, or Putin for that matter, I would pay attention to the export duty. That is the primary lever that Russia can pull to affect exports and hence world prices. If Russia raises the duty, it means it is serious about cutting output. If it keeps the tax low, or cuts it further as the Novosti article suggests, all the talk about cutting output in conjunction with OPEC is just that–talk.