International sanctions against Russia introduced in 2014 turned out not to be the bogeyman they first seemed to be, and could in fact have played a key role in helping the Russian oil sector to not only handle the sharp price drop over the last year and a half, but make the industry more efficient in the long run.
When sanctions were implemented targeting the Russian oil sector’s access to Western financing and key Arctic, shale and deepwater technology, analysts saw them as major blow.
Forecasters speculated that Russian oil companies would run into problems trying to maintain drill rates, service loans in foreign currencies, and could struggle to maintain output. At the time the International Energy Agency estimated Russia’s crude production would fall by 80,000 b/d in 2015. And these forecasts came when oil was still trading at over $100/b.
Things haven’t quite panned out as predicted – Russia increased crude output in 2015 by 147,222 b/d year on year, to 10.73 million b/d, and energy ministry data for January indicates this trend is continuing into 2016.
This is mainly due to a significant increase in drilling, and a drive to concentrate resources on maximizing efficiency at existing projects, rather than invest in new ones that are unlikely to immediately boost output.
Although natural declines continued at ageing fields in West Siberia, companies stepped up drilling efforts to minimize the fall. Rosneft said in November it increased drilling meterage by over 32% in the first nine months of 2015.
Russian production costs are also relatively low – estimated to be between $5/b and $15/b by energy minister Alexander Novak. These costs, which are largely incurred in rubles, have dropped in line with the ruble’s devaluation against the US dollar.
There is no consensus on how long this growth trend could last – forecasts for 2016 run the gamut from output cuts, to flat, to possibly some growth, with the latter increasingly likely if prices rally.
Low prices had bigger impact than sanctions
If 18 months ago analysts were talking about the joint blow of sanctions and low oil prices, the reality is that low oil prices were a much bigger challenge.
When sanctions were introduced, negative forecasts were largely based on the impact they may have on two key aspects of oil producers’ operations – access to Western credit and technology for cutting edge projects.
On the credit issue, when prices began to fall the Russian government pursued a policy of allowing the ruble to devalue in line with the oil price drop. The result was Russian producers actually benefited by reducing their exposure to debt denominated in foreign currency.
In its latest financial results, Rosneft reported its net debt was $24.5 billion at the end of Q3, down 45% from $45 billion at the end of Q3 the previous year.
The second objective of the sanctions, to block access to Western technology has also had little impact.
When sanctions began, Russian companies were in the early stages of considering a wide range of new projects.
While some of these projects have survived in scaled back versions, or without the involvement of Western partners; many have been put on hold indefinitely, such as Rosneft’s ambitious plans for Arctic exploration with ExxonMobil. But with oil prices bouncing around $30/b, these plans would likely have have been killed for economic reasons, sanctions or not.
The West’s cold shoulder also drove a shift to develop domestic oil service capabilities rather than relying on foreign technology. Major oil producers are now producing Russian-made equivalents to equipment previously sourced abroad.
Also, low prices and not lack of technology likely made some companies move away from expensive shale production. But shale hasn’t been abandoned, however, despite unfavorable conditions.
Unconventional oil production actually rose by 0.6% to 32.8 million mt, according to the energy ministry. Surgutneftegaz, the leading shale producer, accounted for 76% of shale output in Russia in 2013.
Using exclusively domestic technology, Surgut is not planning to cut investment in producing these reserves until 2018 at least. Actual costs of shale production in Russia are hard to assess, with many projects still at the pilot stage. Analysts have estimated that projects at the Bazhenov and Domanik shale formations could become profitable at above $40/b.
Many in Russia would welcome the lifting of Western sanctions, and it would undoubtedly be positive for investor sentiment, but without a corresponding recovery in oil prices it is unlikely to have any significant immediate impact on companies’ spending habits and project portfolios.