RUSSIAN ECONOMY WEATHERS A FALL IN WORLD OIL PRICES

By Sergei Kolchin

There has long been discussion of Russia’s need to adapt to the new state of the international oil market, characterized as it is by lower oil prices. From the end of 2000 to the fall of 2001, predictions of this kind have ebbed and flowed, depending on specific market changes. In fall 2001, these predictions became reality. The main reason for this was nothing to do with the military operations in Afghanistan and the prospect of conflict spilling over into the Near and Middle East, but the persistent predictions of a slowdown in economic growth in the United States, Japan and European Union countries. The OECD forecasts that economic growth will slow down substantially in the next two years, although outright collapse is not expected (apart from in Japan in 2002). On the other hand, in the second half of 2003 and in 2004, some recovery is expected in the economic growth rate of Europe, the United States and Japan. So the major factor currently determining the state of the world’s oil market is now regarded as no more than a temporary set-back. The fall in oil prices expected in October and November 2001 did indeed take place and the price of a barrel of Brent crude was fixed at a level of US$17-18, while Russia’s Urals crude was quoted still lower. It is forecast that oil prices will remain depressed till the end of the year.

Under these circumstances, much depends on the coordinated policy of the oil exporters. As early as the beginning of 2001, the OPEC countries initiated a coordinated reduction in oil production and exports, in the expectation that similar steps would be taken by the countries outside the organization (Russia, Mexico, Norway and others). As has become clear, these hopes were not well founded, owing above all to Russia’s position. Our country officially justifies its reluctance to reduce its oil production and exports on two grounds: the need to strictly meet its obligations to the importer nations–above all to the EU; and the impossibility of making sweeping cuts in its oil output because of specific geological and technological aspects in the development of its oil deposits. There is also a third factor, not usually aired officially: the critical dependency of the entire Russian economy on its oil revenues.

The first of these arguments seems highly dubious, since the OPEC countries also have obligations to the importers. In Russia’s case, the issue is rather more about the reciprocal obligations of the EU–investments, credits and so on–none of which have yet come under scrutiny. The second argument is more soundly based, as it is harder for Russia to make a temporary cut in its oil output than it is for the countries of the Near and Middle East, especially in the winter months. There is certainly some scope for the creation of a national oil reserve, but this concept has not yet been sufficiently developed.

The third argument says more about Russia’s ineffectiveness in exploiting the benefits gained while oil prices were high, than about any objective difficulties with the development of Russia’s oil and gas sector. Either way, in recent times the subject of shifting oil prices, together with Russia’s relations with OPEC, has come to the fore. The mechanisms used by the oil exporters to combat the unfavorable state of the world’s fuel prices are well enough known and accepted. They amount to a planned reduction in oil output and exports as a means of balancing out supply and demand on the oil market. The OPEC countries adhere to this proven system, inviting the other oil exporters to follow suit. Their first concern is with Russia, Mexico and Norway. The cartel wants the non-OPEC nations to take a share of the burden of regulating the market. Here it should be observed that any further reduction of oil output, at least in the short term, will deal a blow to the budgets of the oil-producing nations. According to the London Center for Global Energy Studies in 2001, the OPEC countries, with the exception of Iraq, face a shortfall of US$36 billion. While the OPEC countries can still countenance such losses, Russia, with her already strained economic situation, is trying to avoid participating in any international industry-wide measures.

However, OPEC has no desire to continue supporting world market oil prices single-handedly. The organization’s president, Chakib Khalal, announced that OPEC will reduce production by 1.5 million barrels per day only on condition that the non-OPEC producers, in turn, trim their output by 500 thousand barrels per day. This was followed by a statement from Mexico and Norway that they were prepared to reduce their output by 150-200 thousand barrels per day. A similar move was expected of Russia, but for the time being she has limited her own reduction in volumes of oil output to 50,000 barrels per day, although Vice Premier Viktor Khristenko remarked that this decision was not final. The world market’s reaction mirrored these developments. After signs of a possible coordinated production cut, the price of oil rose, but as a result of the Russian demarche it fell back, though not dramatically. There was a simultaneous fall in the value of oil company shares.

The decision on the scale of oil production cuts in Russia was taken by the government after a series of consultations with the ‘top brass’ from the oil companies. The government naturally opposed the strategy formulated by OPEC for the development of the world oil market, but the Russian oil corporations succeeded in pressing their own case with the government. This was a practical demonstration of Russia’s formal intention to have a hand in world oil policy without actually taking on any specific obligations. “We are only prepared to engage in dialog with OPEC and the government, provided we can avoid any sharp fluctuations in the oil market,” declared one of the representatives of the main pool of Russian oil companies, the president of Sibneft, Yevgeny Shvidler. In reality, the Russian oil companies are pursuing a policy of self-interest, disregarding even its most imminent possible consequences. Their practice of shifting the burden of responsibility for external matters on to the leading OPEC exporters, and for internal matters on to the government continues uninterrupted. This is probably the key feature of Russian oil policy, and differs from the normal pattern of corporate market behavior. However, several companies do now consider a reduction of Russia’s oil output to be inevitable. Thus the vice president of Lukoil, Leonid Fedun, said; ” We must cut production, however unpalatable it is for Russian oil companies.” There are grounds for this. Back in October, a government commission headed by Viktor Khristenko cut back the companies’ export quotas by almost 200,000 barrels per day.

In this situation, at least two questions arise from the current state of the world energy market. The first is how to resolve relations between Russia and OPEC, against a background of depressed oil prices. The second concerns the consequences for Russia of the new wave of energy price cuts.

We can answer the first question with the following. The concessions made by OPEC as the current year ends require no particularly painful measures. “By the end of the year our exports will be reduced by 100,000-150,000 barrels per day anyway,” according to government sources. Production and export cuts on this scale are acceptable even to the heads of a number of leading Russian oil companies (Lukoil, TNK and others). In addition, the Russian market is capable of consuming greater volumes of fuel in winter than in warmer periods of the year. So Russia does have a certain freedom to maneuver in negotiations with OPEC.

However, the very principle of relations between Russia and OPEC has still not been defined by the Russian government in any concrete terms. Addressing the question of how Russia should act in its relations with OPEC, Russian experts stress the following points:

1. Russian oil exports will be reduced, but mainly as a result of natural seasonal fluctuations, since domestic consumers do not have the capacity to accommodate growing volumes of oil, nor has Russia any outlets in new external markets.

2. In its dealings with OPEC, Russia will, as before, maintain its status as an interested observer and refrain from entering into any closer or more binding relationship with the organization.

3. One positive factor in Russia’s relations with OPEC is the thaw in Russia’s dealings with the United States, which has made it possible to some extent to resist pressure from the organized oil exporters.

4. The possibility of a price war between Russia and OPEC is advantageous only to the developed consumer nations, although Russia might derive some benefit from such a war by seeing its losses compensated to some degree with the writing off of external debts, for example, which is certainly not an issue for her non-OPEC partners.

5. It is not expected that prices will fall to the mid-1990s level, so Russia should be able to make a relatively reliable forecast for its economic development; but if the average oil price over the year is US$14 per barrel, then Russia’s budget will show a shortfall not only of the 37 billion rubles added to the budget for 2002, but also of a further 30 billion rubles; experts assess that in such an eventuality the growth in GDP would fall to between 2.0 and 2.5 percent in 2002, and to between 1.7 and 1.8 percent in 2003.

As regards the prospects for Russia’s internal economic development now that world oil prices have begun to fall, forecasts are equally varied. Russian experts note in particular that a fall in oil prices to US$15 per barrel would not actually be such a catastrophe for our economy. It is our opinion too that, in such an event, all that will happen will be that business and the government will finally be disabused of the idea that petrodollars are simply there for the taking. Anticipating the present crisis, in 2000-2001 the Russian government repeatedly stressed that the country’s economy was well insured against a collapse in oil prices. It was said that, thanks to the accumulated safety margin, not even a fall to US$15 per barrel would affect the basis of the state’s 2002 budget, or make things critical in 2003. Nevertheless, the inevitable fall in world oil prices has brought confusion to the forecasts and parameters for Russia’s economic development. Nikoil’s analyst Gennady Krasovsky maintains that the fall in oil prices may be more substantial yet–to US$12-14 per barrel–in which case we will have to start eating into our gold reserves. Either way, the government has reached agreement with the leaders of the four centrist factions in the Duma on how to protect the 2002 budget, should world oil prices fall below US$14.5 per barrel. According to their agreement, every budget provision, except for those deemed socially significant, will be sequestered to a tune of 31 billion rubles.

In the worst-case scenario, the possible options are an enlargement of the state budget deficit, increased external borrowings, or the sequestration of the budget. An expansion of inflationary processes in the economy is also a real possibility.

The preemptive steps with regard to the possible budget sequestration have, in our view, three main objectives. The first is to protect the reserves in the event that the unfavorable world oil prices should become prolonged (given that our gold reserves are currently fairly sizable but not limitless). The second is to renew the pressure on the “leftist” elements in the Duma with the watchword, “We have to live within our means,” while keeping in reserve the option of a number of concessions to them in the areas of welfare and social programs. The third is to increase the room for maneuver in negotiations with Russia’s creditors abroad. Linking debt repayments with investments–hardly likely while fuel prices are high–is now becoming a more realistic prospect.

In our view, the final conclusion to be drawn from the current state of Russia’s development, against a background of relatively low oil prices, is that a re-examination of the priorities and objectives of the country’s economic policy, as well as its role in international economic relations, is now essential.

Dr. Sergei Kolchin heads the sector of economic statistics and comparative international analysis of the Russia Academy of Sciences’ Institute of International Economic and Political Studies in Moscow.