Despite challenges & sanctions: Russian oil & gas remain profitable

Russian oil & gas remain profitable

By Tom McGregor, CNTV Commentator

CCTV.com attended the 2015 Moscow Forum, hosted by the Moscow City Government. Local officials discussed Moscow’s business climate. We will post a 5-part series of Special Reports, ‘China’s New Silk Road connects with Russia.’ This is Part I.

Doomsayers have raised alarm bells over Russia’s economic decline, and they anticipate even worse to come. They point to dramatic oil & gas price drops as the crucial indicator since the nation’s capital city is a global energy hub.

Industry experts have told CCTV.com they forecast oil prices to stay in the doldrums for another five years.

Russian oil & gas companies must confront destabilising geopolitical factors, such as Western governments imposing sanctions on them, steep valuation drops of Russia’s currency, ruble, and a recession.

Nonetheless, Moscow is undergoing a construction boom and Sergey Cheryomin, Minister for External Economic and International Relations of Moscow, claims the city’s unemployment rate for the working-age population stands at 1-2 per cent.

Russian oil and gas companies also appear poised to overcome challenges and perhaps they have a few good reasons for optimism.

Low production costs to the rescue

Last week, crude oil prices have plunged to under $US40 a barrel, the lowest level since 2009. But, Russian oil & gas conglomerates believe they can weather the storm.

“Russian companies can pump oil, because their drilling costs are low, $US3-$10 per barrel and they enjoy preferential tax treatment,” said Alexis Rodzianko, CEO of AMCHAM (American Chamber of Commerce, Moscow Chapter).

He added, “They still report good production and maintain high profit margins. For the time being, they will abandon offshore drilling, because it’s more costly.”

Ironically, Western-imposed sanctions have sparked a localization trend that benefits Russia-based oil & gas equipment manufacturers, while domestic companies are offering more technical training programs for its employees.

Moscow’s city government has opened up hi-tech industrial zones – Technopolis Moscow and Skolkovo Innovation Center – to encourage startups to invent more efficient and cheaper equipment and technologies for Russian oil & gas operations.

Localization creates opportunities for China

Chinese oil and gas companies are increasingly entering into lucrative agreements with their Russian counterparts. Gazprom, the Moscow-based oil and gas giant, has agreed to supply China with 38 billion cubic meters of natural gas for a period of 30 years starting in 2018. The total estimated value of the deal is around $456 billion.

Due to sanctions, European and North American companies are not able to participate or benefit from these deals. China, being the largest consumer of fossil fuels in the world, is heavily reliant on Russia’s abundant supply of reliable energy sources.

Both countries depend on each other and should treat each other as equals. Russia is a major energy supplier, and China has the means to pay for it, even amidst the sanctions. As the popular saying goes, “A friend in need is a friend indeed.”

Ruble devaluation has its benefits.

Despite the gloomy state of the economy, Russian exporters can potentially benefit from the sharp decline of the ruble. This is because when the currency of a nation drops, it tends to favour exporters while putting importers at a disadvantage. This means that Russian oil and gas firms can export their products at lower prices, and equipment manufacturers situated in Russia can sell their goods and services to foreign investors at reduced costs. This particular situation can be advantageous for Chinese investors. However, North American and European firms have not been able to take advantage of the ruble’s devaluation since they have been locked out of Russia’s oil and gas markets. As a result, Beijing can gain significant benefits from this situation.

China-Russia partnership on the rise

Washington, London, and Berlin would stand firm on imposing sanctions against Russia for at least another six months, according to AMCHAM’s Rodzianko. Moscow does not intend to act subservient to other nations to escape punitive measures.

Nonetheless, Beijing does not engage in “exceptionalism” foreign policy and would not punish Moscow economically for its perceived actions over Ukraine. China has taken a more pragmatic approach with its neighbour to the north.

Consequently, Russia’s oil & gas companies can grab greater prosperity by working more closely with China.

Comments by Sol Palha

Most of the naysayers in the West have a hard time dealing with the fact that China is destined to overtake the US. The U.S in its quest to undermine Russia and China has done nothing but hasten the speed of its demise. China is already the World’s largest economy when in considered in term of PPP (purchasing power parity). Many view this as being a more important measure of how fast an economy is growing as opposed to looking at the GDP in nominal terms only.

Economic growth in America is based on debt and in that sense, both China and Russia have actually surpluses to draw from, while the U.S is nothing but a debtor nation that relies on its ability to create money out of thin air to give one the illusion that the economy is thriving. The economy is not thriving, if it were we would not have a record number of individuals on Food stamps and 76% of Americans would not be living from paycheck to paycheck.

Long-term opportunities in China and Russia

The entire oil and gas sector has taken a beating. Still, more importantly, some key blue chip companies in Russia have been decimated due to the illegal sanctions the U.S has imposed on Russia. Europe, which for now is just a concubine of the U.S., has no option but to follow its master’s commands.

In China, markets are correcting for two reasons;

1) Masses rushed into the markets without knowing what they were doing, so all this excess money is being drained out of the system. This is classic psychology at play. When the masses are happy, you should be wary and vice versa.

2) The Chinese government is slowly seeking to impose reforms that make it harder for so-called state enterprises to operate on forever loans while doing nothing to improve the bottom line. The new mandate is to get the house clean, even if this means a few large companies going belly up. The idea put forward now is for such large enterprises to consolidate and improve their operating efficiency. In the short term this will lead to pain, but in the long term, it will provide the basis for a more efficient operating system.

In a recent essay titled “Chinese markets short term mess, long term great buy ” we highlighted why we thought China makes for a great long-term investment.