Rising Costs Threaten Russia's Output Growth

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Russia is itching to produce more crude, but its output may not reach the lofty levels Moscow has put forward. The loosening of Opec-plus restrictions in August-December, as well as a higher baseline, has created a euphoric atmosphere in Russia (PIW Jul.30'21). Deputy Prime Minister Alexander Novak, the country’s chief negotiator with Opec-plus, has said output could reach the “pre-pandemic” level of 10.5 million barrels per day in May 2022, up from 9.6 million b/d in July. However, this forecast seems optimistic since many wells shut in to meet the Opec-plus quota are unlikely to restart. Energy Intelligence estimates that output next May, excluding gas condensate, will be 10.2 million b/d, while fourth-quarter 2022 production would average just over 10.3 million b/d. Russia’s crude output hit its historic peak of 10.6 million b/d in October 2018, and capacity is now assessed at 10.5 million b/d. Novak went so far as to say that crude output could reach 11.5 million b/d in early 2023, which is the new production baseline pursuant to the latest Opec-plus arrangement (PIW Jul.16'21). But this is seen as far above the country’s capacity, and Novak added that he viewed the number as “an opportunity” for the industry rather than a target. By granting Russia a baseline 1 million b/d higher than capacity, Opec-plus, in addition to enticing Moscow to stay in the alliance, opened new vistas for Russia’s oil sector. But boosting output up to, and beyond, 11 million b/d in 18 months looks unrealistic. Extracting oil in Russia is getting more expensive. Production costs have tripled over the past decade and reached a 10-year high in the second quarter this year. The tax burden has grown, and the massive, untapped fields that majors must develop to raise output are more technologically complex. So any ambitious production targets lead to poignant questions about whether Russia’s new barrels would be competitive, particularly in light of the accelerating energy transition and the prospect of peak demand later this decade (PIW Aug.6'21). According to data from Russia’s state statistics service (Rosstat), crude production costs in April-June totaled 20,379 rubles ($275) per metric ton, or almost three times more than nearly 7,200 rubles/ton in the same period of 2012. In dollar terms, production costs grew by 18% over the period to $37.47 per barrel in second-quarter 2021. It is not fully clear how Rosstat crunches the numbers, but Energy Intelligence understands that the calculations include both operational and capital costs, as well as taxes and other expenses. To compare, Saudi Arabia's marginal cost is about $20/bbl, according to Energy Intelligence's Research & Advisory unit (PIW Jan.22'21). Any significant growth in Russian oil output will require tax relief. Experts point out that taxes, which have always been a way to regulate production, were a key factor in the country’s runaway production costs over the past 10 years. The devaluation of the ruble that started in late 2014 helped, putting downward pressure on costs starting in late 2014, but this effect ceased by 2018. If Moscow wants to see sustainable production growth and support oil companies’ plans, it will have to reduce taxes, analysts say. Rosneft’s financials show that its tax burden, excluding income tax, stood at 2.12 trillion rubles ($28.6 billion) in 2020, or three times higher than 645 billion rubles back in 2012. The mineral extraction tax that Rosneft paid in 2020 amounted to 1.31 trillion rubles versus just 527 billion rubles in 2012. With the tax albatross on the industry inflating, and the state abolishing tax exemptions and deductions, oil companies keep lobbying for new tax stimuli. After all, they had to travel further -- to the Arctic and remote corners of East Siberia -- and drill deeper to compensate for natural declines at traditional West Siberian fields, requiring higher outlays and more expensive materials. Rosneft's capex grew year over year by 26% in ruble terms and 15% in US dollars in the first half (PIW Aug.20'21).

Opec-Plus Supply , Opec/Opec-Plus, Crude Oil
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