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Weak Energy Prices Show Russia’s Achilles Heel

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It was just in the beginning of March when Vladimir Putin’s Russia seemed to be at the top of its geopolitical and public relations game. While most of Europe and the United States were dealing with a severe outbreak of COVID-19, Russia’s state media was actively engaged in downplaying the virus. The Kremlin was sending medical supplies to the United States and preparing for the grand military parade in commemoration of the 75th anniversary of the end of World War II. Furthermore, some believed that Russia’s oil price war against Saudi Arabia and U.S. shale was proving successful and would grant it greater leverage in the global crude market.

Fast forward to June, however, and the situation in Russia is strikingly different. Its grandiose military parade has been postponed to June 24 over health concerns, as the country has emerged as one of the world’s worst coronavirus hotspots. Despite First Deputy Prime Minister Anton Siluanov’s earlier claims of Russia being able to sustain oil prices at $25 per barrel for three to five years, the Government of Russia is already facing an increased budget deficit in 2020, while the nation’s state-owned commodity exports corporations are reporting substantial financial losses. Russia’s tough stance on OPEC+ and US shale has since crumbled, with the Kremlin now cooperating fully with production limits set in place this April.

In fact, Saudi Arabia and Russia are now in discussions to extend output cuts into August, September, and even October despite the original  plan to begin tapering in July. Putin’s willingness to negotiate demonstrates that the 9.7m b/d supply cuts agreed to in April have not been sufficient to bring prices up to where they are needed. No wonder: global ground and air transportation is down over 80% and oil storage capacity is full.

In an effort to continue its energy market damage control, the national oil champion Rosneft has officially disposed of its highly risky, terminally mismanaged Venezuelan assets, passing them on to an entity fully owned and controlled by the Russian government. But while oil prices are expected to gradually increase in the second half of 2020 with the anticipated worldwide economic recovery, natural gas prices may be a slightly different story, which does not look pleasant for Moscow.

Gas prices in Europe are on a fast decline due to weak demand, rising supply of Qatari LNG and energy from renewable sources. The price of the contract for next-day delivery on May 22 fell to a new historic low at less than $26.4 per 1000 cubic meters (tcm) before rebounding. Compare this to $95-$100per tcm in late March - and you’ll see an almost 70% drop in a mere two months. Last week gas prices in Europe’s largest traded energy market – the Dutch Title Transfer Facility – saw gas at $40 tcm. Gazprom pays on average $47 per tcm for transit fees alone, meaning that current prices are not sustainable in the long term.

The Gas Storage Europe Association suggests that by the end of May, Europe’s gas holding facilities were 70% filled, compared to 56% at the same time of last year. Usually, gas storage fills by the end of summer and empties throughout winter.Early gas fills might send the price of future contracts for gas deliveries into negative territory, just like oil prices briefly fell to -$37 at the end of April.

Europe has traditionally been the core market for Russia’s oil and gas exports. Many countries of the European Union, particularly Germany, have adopted a strategy towards increasing the share of the renewables in their energy mix.

Over the previous decade many nations in Western Europe have substantially grown their demand for liquified natural gas as Dutch supply dwindled. Most of that demand is fulfilled by imports from Qatar and the United States, with the two countries providing almost half of the EU’s total imports of LNG.


Furthermore, Germany’s energy market regulator, the Bundesnetzagentur, has ruled that the construction of Gazprom’s controversial Nord Stream II pipeline would violate the European Union’s energy unbundling rules that require separate operating companies for the production, transportation and distribution of energy. Although the regulator’s ruling will not affect the ongoing construction of the pipeline, it will certainly add to its operating challenges. Satellite images have emerged depicting continuing works, which has prompted several U.S. Senators to begin drafting another round of sanctions against the companies involved in the construction of the Nord Stream pipeline.

Meanwhile, major gas suppliers are unlikely to reign-in their production fearing the opportunity costs of missing the recovery of natural gas price. On May 22, Qatar Petroleum announced it would not cut its LNG exports to Europe. Furthermore, on May 25 the corporation announced its plans to continue North Field expansion projects, which are expected to raise Qatar’s LNG production capacity from 77 million to 110 million tons per year by 2025.

 A similar trajectory is expected of the U.S. production of LNG - in January a 30% rise was predicted for the current year, along with a further 18% increase for 2021. The International Energy Agency earlier suggested the United States would claim the title of the world’s number one LNG producer as soon as 2022 (whether that holds true remains to be seen).

On top of the severe coronavirus outbreak within Russia, the oil glut and the prospects of the global natural gas market are painting a rather grim picture for the country’s main currency earning commodities in the coming months.

The Kremlin’s heavy dependency on exports of hydrocarbons has never been a secret, but 2020 has fully unmasked the risk of a monoculture economy. One would think that the staggering drop in global demand for oil and natural gas, as well as the abundance of cheap oil in many parts of the world, would weaken Russia’s geopolitical position and significantly limit its ability to flex muscles overseas. However, the recent Russian enhanced posture in Syria and Libya suggest that global economics have not affected Russia’s geo-strategic stance just yet. This may change as the year goes on and hydrocarbon revenues dry up.

With assistance from Bogdan Puchkov

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