#10
From: "Stanislav Menshikov" <menschivok@globalxs.nl>
Subject: DILEMMA IN OIL. Cutting Production Is Essential
Date: Fri, 23 Nov 2001
"MOSCOW TRIBUNE", 23 NOVEMBER 2001
DILEMMA IN OIL
Cutting Production Is Essential
By Stanislav Menshikov
The Russian government is faced the dilemma as to whether join OPEC in cutting oil output or succumb to the probable collapse of oil prices. Because Russia is a large producer and the second world's top exporter of crude it should have long worked out contingency plans for all possible scenarios of oil market behaviour. As it turns out, the government seems to be at a loss as to what course to take, and divergent views taken by oil companies add to the confusion.
Predictions that prices would fall abounded throughout the year. The 2002 federal budget drafted last summer provided for an optimistic scenario T $23.5 per barrel and a pessimistic one at $18.5 per barrel. Since then the outer world slipped into a recession, and government officials are now talking about optimism at $18, pessimism at $14 and catastrophe at $10 or less. Pessimism means a budget deficit instead of a surplus and the need for new foreign loans to pay the bills. This does not necessarily mean a significant slowdown in overall economic growth, but it does entail serious fiscal problems.
The logical course to take when faced with shrinking demand is to stabilise prices by reducing supply. This is done by all businesses that enjoy an oligopoly position, i.e. have the market power to influence prices by manipulating output or sales. Such a position is enjoyed by OPEC if it works in co-operation with leading non-member oil exporters - Russia, Mexico and Norway. Of these Russia is by far the largest and its attitude is crucial. Recently OPEC suggested cutting its own output by 1.5 million barrels per day if the outsiders also joined in a 0.5 million cut. In this scenario Russia's share would be around 200 thousand barrels, or 3 percent of its current output. Hardly excessive. But Russia reciprocated with only 30, then 50 thousand, which is a drop in the bucket. While oil prices initially surged on the news of a pending deeper cut, they subsequently fell even further in disappointment.
The reasons for such inaction are not clear. The government seems to put the blame on oil companies, who refuse bigger cuts in output. In fact, only two of them have done so, namely YUKOS and Sibneft, while LUKOIL, the largest producer, and TNK have agreed to cut. According to Mr. Fedun, LUKOIL vice-president, selling "less at 15 percent higher prices is more profitable than producing 5 percent more in a falling market". The reason for objecting to cuts given by Mr. Khodorkovsky, president of YUKOS, is that his company was heavily investing in expanding output and to stop doing so would be a loss to itself and to producers of oil equipment. However, he did not explain why producing more at lower prices is more profitable than moderating output at higher prices. The explanation, though, leaps to the eye: when export prices fall below a certain point companies do not have to pay export duties, so they are compensated for the fall in revenue by a significant saving in taxes.
Obviously, every oil company has its own profit maximising formula. But the function of the government is to maximise national economic well being. In the case of YUKOS, company interests come into conflict with national financial stability. The government has every right to exercise its authority over oil pipelines to cut exports of crude. This should not necessarily work against oil producers. First, it is an emergency measure to be repealed when conditions improve. Second, the government should buy some of the excess supply for replenishing strategic reserves. Third, more exports of refinery products should be permitted to compensate for lower exports of crude. And an understanding should be reached with OPEC that Russia would be cutting exports and production but in quantities sufficient to stabilise prices at mutually agreed levels.
It could be that the failure to take such measures is caused by political motives, to wit attempts to please the West at a time when lower oil prices might help overcome economic recession. Hints have been made that Russia would like to become an alternative source of energy for the industrialised world at the expense of traditional Islam suppliers. Perhaps, some of the rhetoric aimed at "OPEC ultimatums" is caused by these considerations.
If so, it would be a dangerous strategy to pursue. Neither the US nor the EU have so far expressed willingness to guarantee a market for Russian oil at a fair price, for instance at $20-22 per barrel. Nor is there a realistic chance to accommodate such an arrangement within a competitive market environment. It is also dangerous because Russia's explored oil reserves do not permit it to become a second Middle East. The country would do much better by exploring and investing more, but producing moderately until the time when its output/reserve ratio improves considerably. Otherwise we could be well running out of oil by 2015 or earlier,
Cutting oil exports and production is a necessary short-term measure consistent with the national interest. The time to make the decisive move is now.
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