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16 April 2020

Where does Russia stand in the oil market turmoil?

The coronavirus pandemic has seen demand for oil plummet globally amid partial or near-complete lockdowns of many national economies. Understandably, this is taking a particularly huge toll on countries that get a considerable part of their revenues from oil.

Fares Kilzie, the founder of independent investment company Creon Group, shares his views on what the recent developments in the industry mean for Russia in particular.

Source: DW.com

Fares Kilzie
Fares Kilzie

DW: Last weekend saw the OPEC+ countries agree to cut production by nearly 10 million barrels per day, about 10% of current global output, following the failure of earlier attempts to do so. The deal came about after US policymakers stepped into negotiations and called for a speedy cut. What do you make of the agreement?

Fares Kilzie: I see the new OPEC+ deal as a tactical retreat preventing a global price collapse. It’s also a huge goodwill sign from Russia to the US.

Soon, other non-OPEC countries will join this global concept, however within 2020/2021 we are likely to see other escalations between several OPEC members themselves since this deal leaves them in a very painful situation.

US sanctions against Russia including sanctions over the Nord Stream 2 gas pipeline, a recent oil price spat between Russia and Saudi Arabia after OPEC+ no longer seemed to work and a decline in oil demand because of the coronavirus spread — will Russia’s energy sector ever recover from this triple blow?

These are very hard and alarming times not only for Russia, but for the entire world. Sanctions on Nord Stream 2 are harming not only Russia, but also Europe and Germany’s future economic growth. Low gas prices and sustainable pipeline supplies will be key to promptly reboot the European economies after the corona crisis.

As for the oil price and the OPEC+ issue, an escalation of affairs was inevitable and programmed from day one of the agreement in 2016. Russia is not and has never been a cartel member. Russia cooperated with a very weak OPEC in order to salvage market balancing, to help itself raise revenues and achieve market stability for all other members, that’s all.

Everybody was speaking of an oil war between Russia and Saudi Arabia; I never saw it that way at all. I saw it as a price shock and a dumping strategy by only one participant [Saudi Arabia].

Indeed, publicly, I was one of the first to call on the Russian leadership to say good-bye to this cooperation in a gradual and acceptable way. The OPEC+ agreement started deforming the shape of the world oil industry and affecting the gas industry, simply backfiring as a cartel pricewise and market-share-wise.

Russia’s dependence on revenues from oil and gas has always been a risky strategy. Do you see any signs of the country moving away from that dependence and becoming more shock-resilient in trying times like today’s?

It has always been Russia’s strategy to reduce its dependence on oil and gas exports. All efforts in the last years have been directed at diversifying the economy. But diversification and modernization need a lot of time and long-term funding.

Russia is much less dependent on oil than many believe. Revenues from oil exports including oil products make up 21% of GDP, in Norway its 32%. Norway exports 14 times more oil per capita than Russia. To give you the relevant figures for oil exports in barrel per capita per year — Qatar: 326, Kuwait: 307, Saudi Arabia: 108, Norway: 177, and Russia: 12.

What’s true is that the oil and gas revenues have been among the main sources of revenue to see Russia through an unprecedented transition despite the sanctions in place. And Europe always was, and I hope will remain, Russia’s partner on this journey, assisting in engineering, the transfer of know-how, supplies and whatever is technically required to reshape the Russian economy.

To sum it up, Russia’s dependence from oil and gas has been going down slowly over the past three years, maybe too slowly due to the sanctions and policies of the government of former Prime Minister Dmitry Medvedev. Maybe COVID-19 will finally set things straight again, so people in Europe and Russia start dealing with the sanctions and lift them. This would help the Russian transition as well as Europe.

You were among the first experts warning that oil prices are bound to remain low for a long time (you said that long before COVID-19 emerged). What consequences should this development have for policymakers and energy giants in Russia?

Policymakers and oil giants in Russia are not on another planet, Russia is integrated in the world economy and also affected by what I think are sometimes wrong decisions of politicians in other parts of the world.

Let me remind you of my forecast of a fair, long-lasting oil price between $40 and $50 in 2017. That forecast was based on many global factors, among them the rapid development of renewable energies and the rise of the shale industry in the US. The latter had thrived on excellent American technology, and that changed the entire oil industry.

But unfortunately, in the last couple of years a large part of the US shale industry got controlled by opportunistic and irrational groups of financial managers who caused massive global chaos resulting in a threat to everyone, including the conventional oil industry in the US itself.

I clearly say that these executives do not represent the solid conventional American hydrocarbon industry at all. Instead of taking real measures to avoid an unnecessary oil tsunami, the managers in question embarked on a path that’s deforming the global oil market.

Could you elaborate on this — what exactly do you think went wrong?

The financial industry in the US was for years heavily investing in companies without any sustainable competitive advantage in the global oil and gas market — companies producing “light” grades of oil which are not required in the US local market or for exports as massive volumes of these grades are available on the market already. Some of the OPEC and non-OPEC countries produce these grades and show a 90% dependence on revenues from them.

Therefore, most of the new oil producing companies in the US are highly overvalued, but the development misleads authorities and Wall Street investors to pump in even more capital to cover considerable ongoing losses. The funding of semiviable and often questionable acquisitions has led to relevant bonds turning into junk papers. I hope that someone in the US scrutinizes those investments soon.

The OPEC+ deal for its part directly influenced the oil market landscape worldwide. It also had an impact on my price forecast, and the deal may end up a huge disaster.

On the other hand, today’s situation will prevent anybody from even thinking about creating a new cartel. All policymakers and oil giants globally can become victims of a single miscalculation. Unfortunately, the real victims of such shock waves are invariably the consumers.

Is Europe still seen as a reliable partner for Russian energy firms? How advanced are strategic projects to focus more on the Asian markets and China in particular?

Russia and Europe have been more than crucial to each other for more than 25 years. COVID-19 will either strengthen bilateral ties and erase the negative factors or ruin relations completely. Let’s all hope for the first option.

At the same time, Russian projects and markets in India and China are the logic consequence of the new Western-sanctions-induced realities, and these projects reflect the demand of these growing regions for a strong, sustainable and resource-rich partner like Russia.

Moreover, Russia is developing its huge territories in the Far East. Those projects focus on Asian markets and China. However, many European companies and economies are benefiting directly and indirectly from this new line of cooperation — companies profit from supplying equipment and services for those projects, and economies at large profit from purchasing products that are not produced, or are not economically viable to be produced, in Europe.

When the virus pandemic is over and the global economy gets restarted, nations around the globe will bend over backward to regain lost ground. Energy companies too will do their best to boost revenues.

Some believe that in a post-COVID-19 context no one will ask anymore how “ecologically friendly” such companies operate. What’s your take on this?

Exactly the opposite will happen. Environmental issues will receive more attention because of COVID-19. I’m confident that the green approach will grow stronger than ever. Investors will understand that all green energies like wind, solar and hydrogen are much safer and more sustainable to invest in.

Unfortunately, every crisis leads to some collateral damage, but the vision of a “green economy” will not fall by the wayside. Having said this, the oil- and gas-operating countries will definitely continue active funding after the pandemic, simply because they already have the necessary infrastructure in place to generate fresh profits. But there must be no more price dumping attempts by anyone.

For almost 30 years, Fares Kilzie has been helping European companies doing or wanting to do business in Russia. He’s the founder of Creon Group, an independent investment and management company focusing on the energy and chemical industries in Russia and the Commonwealth of Independent States (CIS). The Creon Energy Fund invests in Russia together with European technology partners.