Top events of March 2020

The National Energy Security Fund introduces top-ten events in the oil and gas industry in March 2020 and is ready to comment on them in detail.

1. Change in Saudi Arabia’s strategy on the world market, collapse of OPEC+ deal

   This event was behind the catastrophe that we observed in March. Actually, it is possible to say that over the past 10 years this March has been the worst month for the oil and gas industry, and it was full of sad and very sad news. Saudi Arabia produced a new ultimatum at the OPEC+ meeting in Vienna on March 6 being aware that Russia would not accept it. At the end of February, Riyadh suggested cutting oil output by 600,000 bbl/day but in March its proposal surged to 1.5m bbl/day. Russia needed to pause to think it over; it was just necessary for the Russian delegation to return to Moscow to agree such an important decision, but the Saudis did not agree and demanded to settle everything in Vienna. Russia refused, and Riyadh immediately announced it would increase oil production. Saudi Arabia began offering its oil to Europe at dumping prices. Thus, Riyadh radically changed its strategy and started this crazy endurance race.

2. Sharp fall in oil demand

   It was the second component of the “Black March”, the second component of the catastrophe on the oil market. Demand was seriously falling amid the spreading coronavirus pandemic, and the situation was getting worse every day. It began in China where demand was initially predicted to plummet by 5% to 7%, which seemed significant at that time. However, forecasts of decline gradually reached 35% that stands for 25m bbl/day. And this is indeed a real disaster. The situation is obviously extraordinary and unforeseen.

3. Collapse of oil prices

   By April 1, Urals oil had plunged below $15. Meanwhile, when the Russian government considered its possible withdrawal from the OPEC+ deal, the price of $30 per bbl was mentioned as the worst scenario. The reality, however, turned out to be twice as bad as it had been predicted. The collapse of oil prices obviously can be put on top of our rating, but we purposefully placed higher those background factors that led to this main event. This March may be the worst month even over the past 20, not just 10, years, because Russian oil prices plummeted to the level recorded last in 1999. Few observers would remember that Vladimir Putin’s coming to power was accompanied by active struggle against consequences of the 1998 economic crisis. No wonder the opposition later formed the “lucky Putin” concept: as soon as Putin became the President, oil prices went up. However, 20 years later, Putin has returned to the year 1999 in terms of oil prices. Although the current situation is obviously different for Russia, it is a shock anyway, and it is evidently necessary to be ready that this story will last long. These days many people rush to check morning news about oil prices and the coronavirus spread dynamics not expecting anything positive in either sphere. Indeed, there are no good reports in either sphere – it looks like a perfect storm. The state needs the money, but there are no revenues, and it has to feverishly spend reserves.

4. Active discussion of positions of Russia in endurance race vs. Saudi Arabia

   We were discussing throughout the whole March what Russia should do and what its chances are in this crazy race initiated by Saudi Arabia. The logic of Riyadh is understandable: it believes that low prices will kill major competitors that should give up before Saudi Arabia does. This is a typical endurance race. Thus, the main question is, will we die, or the Saudis lose their nerves first? It is quite a difficult question to answer, because, on one side, our state budget is balanced with oil prices at $42.4, while the Saudi budget fairs at $80. On the other side, the $80 level is what international organizations estimate, as nobody knows for sure what is going on in Saudi Arabia, because its state budget is a secret, and they do not disclose data. Nevertheless, Riyadh’s serious advantage is low production costs of Saudi oil. Although Rosneft argues that its production costs are $3, this figure is rather misleading, as it takes into account only extraction costs but excludes administrative expenses on the Moscow office, projects of Rosneft, such as those in Venezuela, expenses on transportation and, finally, taxes that the company has to pay in Russia. Deputy Minister of Finance Aleksey Sazanov said that during a crisis it was not the state that should assist oil companies, but oil companies should help the state. With Urals oil prices below $15 per bbl, export duties as of April 1 are $52 per ton, which is more than $7 per bbl. Thus, from $15 it is necessary to deduct export duties of $7 and also transmission expenses and production taxes. Thus, the oil company already generates losses. Well, oil producers obviously have some reserves accumulated in 2018 and 2019, but the situation is rather complicated anyway. The state does not make concessions to oil producers so far, and the latter cannot suspend their production, because it is impossible in the Russian climate, unlike the situation in Saudi Arabia or the USA. If we suspend wells like they do, we will not be able to restore them.

5. First bankruptcy of American shale producer

   Speaking about the Saudi Arabia-Russia oil war, we should not omit the United States of America. It is understandable that the first victims will be smaller oil producing nations like Nigeria and Algeria. Some say that the oversupply on the oil market is some 15m to 20m bbl/day and even 25m bbl/day – the latter figure is the combined oil output of Saudi Arabia and Russia. In this regard, nobody will notice the “oil death” of Nigeria. Therefore, this race is mainly between the USA, Russia and Saudi Arabia. First bankruptcies have already begun in the USA. On one side, the USA has quite stable positions, because shale produces are insured. Secondly, some majors are in the shale business, and they can obviously support it. Thirdly, the USA undoubtedly has some potential to subsidize shale producers. On the other side, there are certain nuances. For shale producers being insured means that insurance companies will have to suffer huge losses. The latter, however, do not want it. Financial companies perceive collapse of oil prices as a possibility to hit the shale industry and its lobbyist President Donald Trump. Hitting the US economy is almost the last chance to change the layout of forces in the presidential race. Paradoxically, part of American business elites is interested in an economic crisis, because it would be a direct blow on Trump who they hate. It means, the worse the situation is for shale producers and Trump, the better it is for the Democratic Party and the higher its chances are. This paradox of the election campaign indeed exists. Only by killing the US economy, it is possible to prevent reelection of Trump. This is why the oil war creates a difficult situation for the USA.

6. Trump phones Putin and Saudi king

   It was an important event for the world oil market, because the ongoing frenzy could be stopped only by oil negotiations between Russia, the USA and Saudi Arabia. It is more difficult with the United States, because political competitors watch Donald Trump very attentively. Antimonopoly regulations are very strong in the USA not allowing America to enter any oil cartel agreement. Thus, Trump legally cannot make such promises, as regulations have him bound hand and foot. On the other side, power verticals and political systems in Russia and Saudi Arabia are simpler. They certainly can make such commitments, but relations between Russia and Saudi Arabia are very complicated now. Trump should act at least as a mediator in this situation and persuade, largely Riyadh, to return to the negotiating table, because only resumption of political talks between Moscow and Riyadh can stop this madness. Otherwise the situation may go into a tailspin. The Russian economy will certainly hold out for some time, but it would be bitter to see financial reserves being burnt in such a way.

7. Collapse of gas prices

   We obviously watch the oil market very carefully, but there is also a gas market where the situation is also disastrous. Gas prices are already at $80 per 1,000 cu m on the European spot market. It looks fair, as gas prices are linked to oil prices. However, the former are also influenced by another factor – oversupply amid the coronavirus pandemic and LNG sales – this situation creates another perfect storm. The perfect storm on the oil market seems not to be enough – we have another one on the gas market. It is remarkable that in Russia there are calls not to reduce LNG production but to increase and deliver it to the European market to make prices lower. It is said that such a situation will create more difficulties to our competitors – LNG producers in the USA, Qatar and Australia – and they will have to leave the European market. It is quite an interesting point of view. We think the Saudis behave madly on the oil market, and simultaneously suggest applying their strategy to the gas sphere to kill this market. The situation on the gas market is actually a pretext to come back to our gas strategy and revise it once again.

8. State transfers 9.6% in Rosneft to Rosneft

   At any other time, this event would be an absolute hit of our rating, but in the shade of the unfolding catastrophe this event is almost at the end of the top ten. By the way, reports about it were posted in the media on the eve of the unprecedented week off work. On Saturday, on the sly, Rosneft exchanged its assets in Venezuela for a 9.6% block of its shares. Thus, assets in Venezuela were assessed at more than $4bn, although their real value is almost nothing these days. The Maduro regime is hanging on by a thread; a new regime will not commit to anything. Moreover, even Venezuela’s current authorities have said Rosneft did not have the right to sell these assets to the state. It means the Maduro regime does not recognize this deal. Venezuela actually does not know what to do: nobody buys its crude, although the price has dropped to $5. Rosneft is under sanctions, though previously it tried to deliver this crude to China and India (demand for oil in the latter also has plummeted over the coronavirus, as the country implements quarantine). In the meantime, Trump needs to have Maduro ousted to raise his chances for reelection. And in this situation Russia buys out these problem assets estimating them at more than $4bn, although the only thing they are worth is exchanging them for Trump’s phone call to the Saudi king to persuade the monarch to stop this mad race. This is what these Venezuelan assets can be used for. Rosneft has buried a huge amount of money in Venezuela. Bloomberg estimated unreturned investments in Venezuela at some $8bn to $9bn, but Rosneft argued it was a lie. Meanwhile, the official debt there was slightly less than one billion dollars, which means that really enormous resources were spent. So, we financed our direct competitor on the oil market (NESF has always been bewildered by this situation). And now Rosneft is no longer a state company, and nobody has noticed that. The state share in Rosneft is 40.4%. BP and Qatar Investment Authority have almost 40% combined. Thus, Russia on one side and BP, QIA and Glencore on the other side have almost equal stakes in Rosneft. Although there is state interest in a quasi-treasury stake, it is less than 50% anyway – Rosneft has become a company with state participation. By the way, we have many times pointed out that nationalization in Russia is a period between two privatization processes, i.e. it is a period when assets are alienated to be privatized again later. This is what we are observing right now.

9. Decrease in share prices of oil and gas companies

   There is a popular theory that the coronavirus pandemic will lead to decline in the value of assets all over the world. As a result, property will be redistributed: such assets will be bought on the cheap. The Rosneft case is already an example of this tricky process – the state is getting rid of assets, although it should keep assets realizing that it is not the right time to sell them. Therefore, it is interesting whether there will be any property redistribution in the oil and gas sector as a result of reduction in share prices. Current owners will obviously try to preserve their shares and will even organize paybacks to maintain share prices and prevent unfriendly takeovers. Yet, there will be opportunities for redistribution of assets. We will monitor how the coronavirus pandemic will be influencing the structure of property in the oil and gas sector.

10. Gazprom updates Power of Siberia 2 project

    In any other month this event would be found on the upper part of our rating, but in “Black March” it was hardly noticed and duly appreciated. Gazprom has seriously corrected its project. Aleksey Miller visited Vladimir Putin, and the President agreed to the project that now stipulates connection of fields in the Yamal Peninsula with China, not laying a pipeline from the Urengoy hub to China’s western regions, as planned previously. This project is absolutely different – it is more ambitious and tremendous. This is an essential story for the gas industry, but at present it is outmatched by the coronavirus.