Was it a polite gesture or a slap in the face? Impassioned pleas for restraint from Saudi Arabia?s Oil Minister failed to move the men in the Kremlin. Prime Minister Mikhail Kasyanov?s response to Ali al-Naimi?s suggestion that Russia should join a global oil production cut was the offer of a 30,000 barrel per day reduction, a mere 1 per cent of Russia?s daily exports.
The Saudi Oil Minister scuttled off to Stavanger. His Norwegian counterpart, Einar Steensnaes, listened and said he would think about it. The Norwegians, at least, played it straight but Opec?s emissary arrived in Vienna last night with empty hands.
Ali al-Naimi?s whistlestop tour of the non-Opec oil capitals has proved worse than pointless. It has exposed the vulnerability of Opec to an oil glut and the risk of a price collapse. The consequence today of severe economic hardship in Arab and Islamic countries is chilling to contemplate.
During the past fortnight, members of the oil producers? cartel have been upping the ante, calling first for a production cut of one million barrels, then 1.5 million barrels. As the Saudi minister left Stavanger, he called for a production cut of two million barrels per day.
Oil traders were unimpressed. Since September 11, the price of a barrel of Brent crude has been in freefall, tumbling from almost $28 to $20 per barrel. Ali al-Naimi?s bold suggestion that non-Opec sacrifice 500,000 bpd in a global two million bpd contraction added just 6 cents yesterday to the Brent price. It is a measure of disbelief that the cartel can afford to cut by such an amount, much less coerce the Russians and Norwegians. As Opec ministers retreat into their usual huddles in Vienna, each will be forced to reveal his hand. This time, no one is holding an ace. Except perhaps Russia, where oil output is increasing in leaps and bounds. The world had forgotten the contribution of Russian oil to global energy supply.
In the 1870s, Rockefeller?s Standard Oil was making good money selling kerosene to light up St Petersburg but only a decade later Ludwig Nobel was shipping oil from Baku on the Caspian Sea up the Volga. By the late 1880s production from Baku had forced Rockefeller out of the Russian empire. Only geography and winter stopped the Russian oil advance into Europe.
Soviet production peaked at more than 11 million barrels per day in the late 1980s and then went into sharp decline as economic collapse followed the disintegration of the Soviet empire. Output plummeted to six million bpd and oil production associations were looted by the new robber barons.
After several years of turmoil, output is again rising, largely because of the high oil prices of 1999 and 2000. The International Energy Agency records a 5.7 per cent increase in output to 6.5 million bpd in 2000, putting Russia in third place after Saudi Arabia and the United States. It is also the third largest exporter after Saudi Arabia and Norway, selling 2.4 million bpd, mainly to Eastern Europe and the Mediterranean.
A new sense of purpose is driving Russia?s oil companies. Mikhail Khodorkovsky, the chairman of Yukos, points to his company?s 12.2 billion barrels of oil reserves, larger than any of the top three Western producers, ExxonMobil, Shell and BP. Yukos has cleaned up its image, publishing Western-style accounts. Its boardroom is bristling with committees modelled on Western corporate governance principles but political risk still dogs the Russian oil producers; investors value some
1.2 million bpd from Yukos at just $8.5 billion, less than three times the company?s earnings. The three sisters of the West are priced at almost 16 times their earnings.
Nonetheless, Khodorkovsky is ambitious. ?We have a clear objective in the medium term of becoming a major international oil company.? Yukos, the second largest Russian producer after Lukoil, is growing fast, its oil production rising 11 per cent last year and 17 per cent in the first half of 2001.
Getting Russian oil out of the ground is not a problem. The companies know where the oil is and they know how to extract it. Production costs are relatively low, just over $2 per barrel. The problem is infrastructure. ?Russian oil production is only held back by market accessibility,? says Khodorkovsky ? a route to market, Russia?s eternal ambition and a constant worry for Saudi Arabia, which has seen its market share dwindle as non-Opec producers rush to profit from high oil prices, courtesy of Opec cutbacks.
But Saudi Arabia?s effort to find common cause with Russia is probably doomed to failure. Even self-interest militates in favour of Russia keeping the taps open, explains Dima Avdeev, oil analyst at the Moscow stockbrokers United Financial Group. ?Russia is not keen to enter this game. It is much more attractive to let other countries underproduce. Russia is less dependent on oil prices than Saudi Arabia or Kuwait.?
Russia does need oil income. Excluding natural gas, oil accounts for about a quarter of Russia?s export earnings and some 15 per cent of government revenue. UFG reckons that the breakeven point for the Russian budget is a Urals oil price of about $18 and, with Brent crude between $20 and $21, there is some headroom.
Moreover, the Russian Government has little ability to control the private sector producers. Were it to block crude exports, Yukos and Lukoil would sell more petrol and diesel into Western markets.
But at the core of Opec?s weakness is the price vulnerability of Saudi Arabia and its Gulf allies. The cheapness of Saudi oil ? production costs are said to be just 50 cents per barrel lifted from the ground ? belies the true cost facing Aramco, the state producer. This is not just a nationalised industry but the only industry. On top of paying for Aramco?s massive workforce are the 15,000 Saudi princes, the subsidised utilities, the Al Yamamah arms purchases and the vast state payroll. Add it all up and you have a breakeven price of $21 per barrel, without repaying a penny of Saudi Arabia?s massive debt burden.
In Washington, the Bush Administration has noticed the distress of its Middle East protectorate. Hence, the decision to mop up some surplus crude by replenishing the US strategic petroleum reserve. A gesture, but little more than that.
Meanwhile, the Russian oil companies plot their expansion. China is the target, its hunger for fuel provides a market for Eastern Siberian crude and a 2,400 kilometre pipeline is proposed linking Angarsk, near Lake Baikal, with the Chinese pipeline networks at Daquing in Manchuria. Exports to Western Europe will be enhanced by the Baltic pipeline project bringing 800,000 bpd of Siberian crude from Timan-Pechora to a new terminal near St Petersburg.
Opec has no choice but to live with rising Russian exports. Siberia will never supplant Opec. Unused Saudi export capacity exceeds Russia?s daily sale of crude and with more investment the Kingdom could increase that potential even further, enhancing its role as marginal producer. Over the long term, the Arab oil producers will regain and increase their share of the market. If they can survive politically in the short term. With economic recession looming, fragile Opec governments will come under huge domestic pressure to break ranks and pump oil for political survival. Should that happen we could be back in the world of $12 oil and the consequences would be dire for everyone.
Author: Carl Mortished
