Russia agreed to take unprecedented volumes of crude off the market under a new OPEC+ agreement in April, in response to dire crude demand forecasts and storage concerns.
Russia has signed up to cut 2.5 million b/d in May and June, 2 million b/d from July to December, and 1.5 million b/d from the start of 2021 to the end of April 2022. Its baseline for these cuts is 11 million b/d.
Commitments and possible cuts by OPEC+ and other producers. Click to enlarge.
These volumes are significantly greater than Russia’s commitments under previous OPEC+ agreements, and pose a major challenge for Russian oil companies. Due to Russia’s difficult climate conditions, and the advanced age of many fields, producers have long claimed that altering output volumes at their projects is technically complex and requires some time. There are fears that wells that are shut in now may never produce again.
Russian energy officials and producers have said they are willing and able to meet these targets, however. Russian analysts said they likely don’t have much choice, with prices low and demand forecasts so negative that producers would have had to make significant cuts, with or without the deal.
Russian crude output will be topped up by condensate, which is exempt from the agreement. Analysts expect condensate to push Russian output over 9 million b/d in the first two months of the new deal. Russia does not provide separate figures for crude and condensate production. In March combined output was 47.78 million mt, or around 11.294 million b/d.
Even so, producers may need to make cuts at almost all projects in Russia to meet the new targets.
Supply impactIn terms of the supply impact, analysts expect deliveries to Europe to be most affected by the new agreement. Shipments to Asia via the East Siberia Pacific Ocean pipeline have been trading at a premium, and are supplied under long-term contracts. There are also signs of a demand recovery in China, whereas much of Europe remains under lockdown. In March Russian exports totaled around 4.99 million b/d.
Deliveries to Russian refineries are also likely to be affected, but much depends on the severity and duration of the lockdown in Russia, which at this point is hard to predict. Russia supplied around 5.98 million b/d to the domestic market in March. The maintenance season, which is due to continue into June, will also impact demand.
Policy changeThe April agreement marked a sharp change in Russia’s approach from early March, when OPEC+ talks collapsed without an agreement. Russia had refused to commit to anything beyond an extension of the existing deal for another quarter. Producers were then free to pump at will from April.
Part of the reason for Russia’s reluctance to agree in March was that it has amassed healthy international reserves and boosted its sovereign wealth fund since the OPEC+ deal came into force and it introduced a fiscal rule in 2017. This resulted in a state budget and oil production economics that were considerably more resilient at the start of this year than in 2016.
Immediately following those talks Russian officials said they were happy with oil prices at $25/b and were prepared to maintain their market share. Over the course of the next month a lot changed, however, as much of Europe went into lockdown to minimize the spread of the coronavirus, and Russia itself began to take measures to combat the pandemic.
Analysts pointed to the unpredictability of demand until the end of the year, as well as concerns over storage, as bringing Russia around to a much bigger cut than was proposed at the previous meeting.
In early April, forecasts indicated that storage would reach capacity within months. Russia itself has limited crude storage capacity, significantly less than the US and Saudi Arabia, with some analysts estimating that it may be as low as a few hundred thousand barrels.
Domestic storage options include some capacity at production projects, refineries and tankage owned by pipeline operator Transneft. Transneft does not provide figures for its storage capacity, and says that its network is not designed for storing crude, with tankage storage used just to ensure that the network runs smoothly.
Furthermore, a major contamination of crude in the Druzhba pipeline last summer has resulted in oil that contains excess chlorides taking up space in some of Transneft’s storage network.
Finally OPEC+ managed to get some encouraging signs that producers outside OPEC+ will also cut production in the near future. Russian energy minister Alexander Novak said he expects producers outside the group to cut a further 5 million b/d, on top of the OPEC+ cut of 9.7 million b/d.
But this could still prove insufficient to stabilize the market, with analysts predicting oversupply of 20-25 million b/d over the next few months.