November Russian Oil Production Climbs Again; Gas Production Continues Recovery

Oil: What a Difference a Year Makes

At this time last year, the Russian oil industry was resigned to seeing its output decline for the first time in a decade. After 53% growth in output from 1998 to 2004, the country's oil production growth slowed significantly from 2005 to 2007 as higher taxes placed a greater burden on Russia's oil firms. Still, until 2008, the domestic oil industry managed to churn out enough output to register positive annual growth through 2007, but the lack of funds available for investment in new production finally took its toll, with output slumping in the first four months of the year. The government's move to introduce a tax cut to stabilise the industry provided a brief respite (while soaring global prices provided the incentive), but the epic price crash, together with the government's slow response to reduce the time lag in altering export tariffs vis-à-vis prices, served to ensure that domestic oil producers would fall short of matching their 2007 output.

Fast-forward one year and the difference in the Russian oil sector is striking. Not only has the government virtually eliminated the time lag in setting crude oil and petroleum product export tariffs, making these more responsive to fluctuations in oil prices, but the renewed strength of oil prices (twice as high as this time last year, albeit just over half as high as the July 2008 record) has provided an added incentive to Russian oil companies to churn out more crude. The launch of several new fields—including TNK-BP's Uvat, LUKoil's Yuzhno-Khylchuyu, and Rosneft's Vankor—this year has helped bring about a rebound in Russia's overall oil output, propelling the domestic industry to new heights with a series of post-Soviet monthly output records.

Indeed, the latest monthly data from Russia's Energy Ministry show that the industry established yet another output record in November. Russia's total oil production in the month stood at 41.215 million tonnes (10.07 million b/d on average), an increase of 0.3% from October, when the former monthly record was set. Rosneft, the state-run oil giant, continued to lead the way among producers, with 9.913 million tonnes of oil production in November, followed by LUKoil (7.48 million tonnes), and TNK-BP (5.867 million tonnes, see table). Through the first 11 months of the year, Russia's total oil production stands at 451.634 million tonnes, up 1% from the January–November 2008 period, and putting the country on pace to return to positive growth for the year.

Gas: What a Different Year

A snapshot of the Russian gas sector shows an altogether different picture. Although gas demand was already plunging in the fourth quarter last year, weakened by the eruption of the financial crisis and the economic downturn, Gazprom, the Russian gas giant, was at least enjoying record prices in its oil-indexed export contracts with its European gas consumers. In retrospect, that was the high point for Gazprom, as the last month of 2008 brought with it rising tension with Ukraine that exploded in January in a new Russian-Ukrainian gas war. The end of the two-week disruption in Russian gas exports to Europe brought only cold comfort to Gazprom, as the economic downturn continued to sap demand in Europe and in Russia itself, forcing the gas giant to curb its own output and then stop importing gas from Turkmenistan altogether in April.

The six-to-nine-month time lag in Gazprom's oil-indexed supply deals with its European customers helped shield the firm from the collapse in volume sales through the first half of the year, but the firm continued to shut in production (and prod Russia's oil companies and independent gas firms to curb their gas output by restricting access to the domestic pipeline network) through most of the first half of the year. Gazprom has talked up a recovery in European demand over the past few months, although its forecast for a rebound in European gas demand looks positively rosy compared to more pessimistic views put out by the International Energy Agency (IEA).

Still, while Russia's overall gas demand is down year-on-year, there is no denying that the country's gas production picture is better now than it had been earlier in the year. In November, Gazprom produced 47.12 bcm of gas, up 8.4% from October but also 6.1% higher compared to November 2008 (see table). Russia's total gas production in November stood at 57.80 bcm, up 9.3% from October and 6.3% higher than in November 2008. Nevertheless, even as the data lend support to Gazprom's claim of a tentative recovery in European demand, the country's overall gas production in the January–November 2009 period was just 519.41 bcm, down 14.5% year-on-year. Colder temperatures, together with the continued threat of a new Russia-Ukraine gas war (and Gazprom's determination to impose take-or-pay penalties on its European consumers who fail to take minimum gas imports under their contracts) should equate to higher Russian gas output in December as well, but the country's gas production overall will still fall short of 2008 levels.

Outlook and Implications

Whereas 2008 was a bad year for the Russian oil industry and a good year (overall) for the country's gas producers, the situation has been flipped on its head in 2009. The latest monthly data from the Russian Energy Ministry signal that domestic oil producers will achieve the government's goal of returning to positive annual growth for 2009, even if the pace of growth still falls well short of the "golden age"' from 1998–2004. On the other hand, the latest figures show that the situation in the Russian gas sector has apparently already bottomed out, with the month-on-month increases (mostly a function of the seasonal demand) less significant than the year-on-year growth in output.

Still, there are serious doubts as to the sustainability of the positive growth in Russia's oil output, as well as the tentative recovery in gas production to meet demand. The Russian oil producers themselves have argued that the current rebound is an aberration, saying that this is a function of the launch of several new projects coinciding, while stepping up their lobbying campaign for additional tax cuts to provide incentives for investment in new exploration and production. The government, for its part, has been reluctant to heed this call, given its own reliance on revenues from the oil sector, although it has scrapped (for now) export tariffs on several key fields in Eastern Siberia, while the coming launch of the Eastern Siberia-Pacific Ocean (ESPO) pipeline should provide further incentives for oil firms to ratchet up output. Nevertheless, more still needs to be done to put the oil sector on a path to sustainable production growth, including revisions to the export tariff-setting methodology itself.