War Heaps New Challenges on Russia's Upstream

Even before the Ukraine war, Moscow had not been very bullish about its oil production prospects. Prior to last February's invasion, the Russian government had assumed output of crude oil and gas condensate had peaked in 2019. Much has changed since then, making the outlook more challenging. Foreign majors and many oil-field services (OFS) companies have exited Russia; Urals crude now trades at big discounts to lure Asian buyers; and Moscow's need for petrodollars to fund the federal budget has increased, adding to the burden on Russian oil and gas companies. It all helps explain why BP in its latest long-term forecast predicts that Russian production could fall by 25%-42% by 2035. BP's latest energy outlook, released this week, says Russia's output will drop significantly under "a combination of faster decline rates of existing operating assets and a curtailing of new prospective developments." It sees Russian liquids production declining from around 12 million barrels per day in 2019 to between 7 million and 9 million b/d in 2035. The high end of that forecast is not far off from Moscow's own outlook in 2021, which envisaged output of crude and gas condensate dropping to 9.45 million b/d in 2035 from 11.25 million b/d in 2019.

This year, Russia's ministry for economic development and trade forecasts that crude and condensate production will average 9.83 million b/d — but Russia significantly outperformed the ministry's expectations last year. Actual output came in at about 10.73 million b/d in 2022, compared to the ministry's 10.33 million b/d forecast. In the near term, the ability of Russian producers to market their crude and oil products and generate healthy cash flows to support investments will dictate production volumes. Russia Deputy Prime Minister Alexander Novak said in December that market pressures could prompt Russia to cut production by 500,000-700,000 b/d in the first three months of 2023, but production in January was on par with the previous month at 10.87 million b/d.

Last year's resilience shows that Russia's oil industry could still surprise to the upside. In 2022, crude and condensate production increased 2% despite sanctions and the refusal of Western customers to buy Russian oil. Expanded drilling activity and efficient well management helped explain the performance. The departure of OFS firms has not had a big impact yet, as many of their assets were sold to local management teams who retained critical expertise. Russia's exploitation drilling increased to 28.4 million meters last year, the highest level since 2015. In 2019, before the pandemic, exploitation drilling amounted to 27.3 million meters. The number of producing wells also reached a record 158,785 at the end of December 2022, the highest in the last five years. Idle wells accounted for the typical 14%-15% of total exploitation wells during most of last year, but the share started rising in March — reaching 21.3% and 18.6% in April and May, respectively. This occurred as Russian companies faced increasing problems with exports after the war started in late February. Russia's biggest oil producer Rosneft had 30% of its wells standing idle in April. Its subsidiary Bashneft had 55.3% of its wells nonproducing in April and 60.2% in May.

On the other hand, the contribution of newly launched fields to Russian production has been modest, and investment in further development will require the right balance between budgetary and industry needs. To protect the state budget from the impact of lower Urals prices, Moscow is considering changes to the tax system that could increase the levy on the oil industry. Russian companies brought on stream 17 fields last year that together produced only slightly above 5,000 b/d. There are 253 fields that have been launched in Russia in the last five years, and their combined production in 2022 was 460,000 b/d. Gazprom Neft's Zhagrina field, launched in 2019, failed to reach targeted output of 110,000 b/d last year, having produced 84,000 b/d. Lukoil postponed the start of exploitation drilling at the Grayfer field in the Russian sector of the Caspian Sea from last December to the first half of this year. Price pressure is mounting. The average price for Urals was $49.48 per barrel in January, according to the finance ministry, far below the $70/bbl assumed in Russia's 2023 federal budget.

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