OPEC+ Jan 4 decision for Feb production is the market focus. However, we believe markets should look at Russia’s last week of messaging on oil markets and realize that its not just to negotiate with OPEC+ for the Jan 4 meeting. Covid and now a view that peak oil demand is coming sooner means that OPEC+ strategy needs to be changed. Its been 4 years and it still hasn’t accomplished its goals. It looks like Russia is coming to the table with a needed new strategy because they seem to truly believe peak oil demand will be sooner. A needed new strategy on how to achieve its key oil objectives – return to full production and maximize the value of its oil reserves. Russia is clearly saying they want to restore its production ahead of non OPEC+ countries (ie. US shale) and oil prices have to be lower (ie. $45 Brent) to ensure that happens. And by warning oil producers and their capital providers of their preparedness for lower oil prices to keep other oil supply down, it sets up continued oil underinvestment and less post Covid oil supply capacity. It may not impact the OPEC+ Jan 4 decision, but by warning all oil producers they will be a price taker at lower oil prices, they set up continued oil industry underinvestment and therefore a better post Covid oil outlook for the 2020s. On top of that, any bumps in the road or delays to Energy Transition will add the potential for short term price spikes in the post Covid oil outlook.
Here is what Russia has recently said in the last week – it’s really signals a change in strategy to fix oil markets. This is why we wrote this blog, in particular the monetization comment that is the clearest signal that Russia believes peak oil demand is coming sooner than expected. Russia’s messaging is that Net Zero is impacting peak oil demand, it won’t happen by 2050, its priority is to restore its production even if oil prices go lower to $45 (they normally refer to Brent), and don’t want others to restore production ahead of them. Russia’s specific comments on oil are often overlooked because most reporting doesn’t go back to the original source reporting. Thanks to Google Translate, it is easy to go TASS Russian news site and search on новак (Novak in English) and find stories. If you compare stories, TASS reports in Russian first, and then normally does a shortened version for their English site. And in some cases, like the critical second story below on monetization, TASS won’t put up an English version. This story was overlooked. We try to go to original reporting where possible and not just write an western news recap of the TASS English story that is a recap of the TASS Russian story.
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Dec 21. Near term reduction in demand from the new UK variant and oil demand recovery to take 2-3 yrs. TASS reporting [LINK] quoting Novak ““Over these two days, the situation, in my opinion, has changed, it is changing quite actively. Serious lockdowns have now been introduced regarding travel to the UK. A new strain of coronavirus has appeared, and this has influenced, among other things, the fact that we are we see a significant correction in oil prices. Two days ago we did not see this yet.” “The market recovery will be slower than initially expected. And therefore our forecasts for the market are changing. Many experts say that it could take about two years. Two or three years, perhaps.” “ Of course, today’s levels of reduction are unprecedented. If four years ago we cut by 1.2 million b / d, and now by almost 10 million b / d, naturally, we are determined to quickly restore this production. we will not upset the market balance or create surpluses in the oil markets.”
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Dec 21. Russia needs to focus on monetization of oil and gas reserves, Net Zero won’t happen by 2050. Separate TASS reporting that did not appear on TASS English news site. TASS reporting [LINK] “In the coming decades, Russia needs to pay special attention to the monetization of energy resources: oil, gas and coal, as demand in developed countries may decrease. This opinion was expressed by Deputy Prime Minister Alexander Novak at the session of the “Russia and the World” project. “My opinion is that in the coming decades [Russia] needs to pay more attention to the monetization of existing reserves,” he said. At the same time, Novak stressed that the global economy will not be able to achieve carbon neutrality, that is, the abandonment of oil, gas and coal by 2050, this can only happen in developed countries. “If you look at the scale of the entire planet, then in 2050, obviously, we will not achieve carbon neutrality. This will happen, God forbid, in developed countries that have announced such goals,” he said. “When we talk about the energy transition, then (you need to look who makes – approx. TASS) statements on achieving carbon neutrality by 2050. We have heard about 2060 in China, few talk about 2040, set themselves such ambitious goals. developed countries and this is not the entire population of the planet. After all, we have a population of seven billion people and in the world energy balance another quarter of energy is produced from coal,” he said.
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Dec 22. Net zero impacting peak oil demand, Russia needs to expand its oil/natural gas exports and surplus global supply from technology ie. frac. The Kremlin transcript from the Novak/Putin meeting [LINK] quoting Novak “Alexander Novak: Thank you, Mr President. May I say a few words about the goals of the fuel and energy complex? Of course, our main goal is to create a proper environment for progress in the fuel and energy complex and to maintain our position on the global market. I see several trends here. In particular, this is about the climate agenda, which concerns putting in certain requirements for a carbon-free economy and carbon-free neutrality. Some countries have already announced their goals and targets up to 2050. This, of course, will significantly affect the demand for conventional energy resources. The second trend is about an excess of resources around the world as a result of technological advances, which will also lower the demand. So, based on the above trends, I believe that we need to concentrate our efforts on two areas: expanding the domestic market, on one hand, and expanding and diversifying our exports, on the other. That includes exports related to added value from processing hydrocarbons and innovative energy.”
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Dec 25. Prepared for lower oil prices to stop others from restoring oil production. TASS reporting [LINK] quoting Novak “To restore our production, which we have greatly dropped, the price range of $ 45-55 per barrel is the most optimal, otherwise we will never restore production, others will restore, and we will be at our level all the time.”
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Dec 29. Net Zero impacting peak oil demand and mid/long term oil price cap of $50. TASS reporting [LINK] quotes Russia Finance Minister Siluanov “it is clear that the demand for hydrocarbons is in a risk zone. After all, these are green technologies, all these carbon taxes, the transition to electricity instead of gasoline in automobiles. All this suggests that it is probably unlikely that prices will remain at the level of $ 50 and above in the long term.”
The most important, and overlooked, oil fundamental post Covid is global oil declines. The primary reason we are more bullish on post Covid oil has been, and continues to be, global oil decline rates especially in the face of lower global oil and gas investment. On Nov 25, the WSJ story WSJ story “Exxon Documents Reveal More Pessimistic Outlook for Oil Prices” [LINK] said “As part of an internal financial-planning process conducted this fall, Exxon cut its expectations for future oil prices for each of the next seven years by 11% to 17%, according to the documents”. The WSJ story reminded of the Exxon CEO Oct letter that talked about industry underinvestment and the implications to future oil supply. The WSJ story didn’t mention it, but the Exxon CEO Oct letter also highlighted global oil decline rates were >7%. This is the major reason to be bullish for mid term oil. While we don’t know the WSJ seen document assumptions, the reality is that its most likely one of four major assumptions that lead to a big drop in mid term oil prices – global oil E&P capital investment is significantly more than expected, near term global oil development has significantly more growth potential at $50 to $55 Brent, global decline rates are less than expected, or global demand is being hit harder for longer. We would assume the biggest change is global oil demand expectations. And that it is unlikely Exxon changed their view on global oil decline rates from Oct to Nov. Our Oct 25, 2020 Energy Tidbits memo [LINK] highlighted Exxon CEO’s Oct 21 email to staff. The headlines were on layoffs and also how Exxon still believes in fossil fuels. But the overlooked point is something for everyone to think about for their perspective on mid term oil – Exxon’s est that the decline rate in global oil is >7%. We believe that whether its 7% or lower at 6% or 5%, its bullish for post Covid oil even if you believe oil demand only gets back to 2019 levels ie. around 100 mmb/d. The Exxon CEO email said “Our outlook projects oil demand to grow at 0.6 percent a year and gas demand to grow by 1.3 percent. With depletion rates, new oil production needs to increase by nearly 8 percent per year and natural gas by 6 percent. Under any demand scenario, depletion supports the need for significant investments.” The implied decline rate in oil is 7.4%. So even if demand doesn’t grow, the world needs to add ~7 mmb/d of new oil supply (either additions or use of spare capacity) to meet oil demand. The OPEC cuts make up a year or so of depletion. Iran and Venezuela return makes up another ½ year or so. To make up for the annual decline is only going to be harder with the lower investment in oil and gas. Even if you believe global oil decline is lower ie. 5%, then OPEC+ surplus, Iran and Venezuela make up about 2 years of depletion. The impact isn’t being felt because the lower capex and declines is masked by the need for OPEC quotas and the demand crash of 20% in 2020. But the point is that once the world recovers to whatever levels post Covid for oil demand (call it 2 or 3 mmb/d), the decline rates and lack of investment will show up in tighter oil markets post 2022. We believe that if the annual decline rate for global oil production is >5%, it is bullish for mid term oil even if oil demand doesn’t grow in the 2020s. Below is the Exxon June 2019 graph that had a similar >7% global oil decline assumption.
Exxon Oil Supply/Demand (mboed)
We have been wondering if some OPEC+ members will tire of waiting for the light at the end of the tunnel. Our Dec 6, 2020 Energy Tidbits memo [LINK] noted this concern. Covid has meant a big delay to OPEC+ meeting their goals. OPEC’s Nov 30, 2020 “Opening remarks to the 180th Meeting of the OPEC Conference” [LINK] said “In this regard, OPEC continues to support the global oil market, in cooperation with its partner countries of the Declaration of Cooperation, which is now in its fourth year. When it has been signed in December 2016, no one would have imagined that DoC will last for 4 years.” One of our concerns has been that the OPEC+ partners are just getting tired of cutting and it hasn’t delivered what they all expected – the ability to return production to higher levels and for higher oil prices. And that we would start to see cracks in the OPEC+ group. Power to Saudi Arabia who appears to have done an amazing job of keeping the group united so far. But we believe Russia’s comments are a clear acknowledgement that there isn’t visibility for OPEC+ to reach those goals in the near term under their current strategy. At least the part of the goal to return to full production. We don’t think the outcome is a breakup of OPEC+ working together. Rather we think that before that happened, we think OPEC would first look to change strategy and we believe Russia’s comments in the last week are a warning that they want to have a change in strategy, maybe not at Jan 4 meeting, but in 2021. Russia has clearly said they don’t want to have others (read US shale) restore oil production before they do and they will take lower oil prices to do so.
The world’s anxiousness to accelerate the Energy Transition is reducing capital from oil and gas to renewable in a bid to catch up ie. less future oil supply capacity. In a lesser oil demand outlook, it means that Russia needs to see a clear path that future oil supply will be definitely be less. The easy way to do that would have been for Russia to cause OPEC+ to split by cranking oil production to full levels, hammer oil prices back to the $20’s and deal a fatal blow to many oil producers around the world. We have always thought this was low probability. But we believe Russia is also signaling they see a more measured near term path (ie. Brent $45) that allows them to get to full production post Covid. And they see this more measured path in part because of the world’s, including many supermajor’s, anxiousness to jump on the accelerated energy transition movement and already move to shift significant capital away from traditional oil and natural gas to new and/or increasing Energy Transition initiatives. Part of Russia’s solution is already being taken car of by supermajors. At the same time, supermajors are also under pressure to keep a lid on overall capex and to sell assets to reduce debt. So its not incremental dollars to Energy Transition, its taking dollars away from future oil and gas production capacity additions. And Russia, like everyone else noted, Shell CEO van Buerden’s Oct 29 comments on the call with the media following the Q3 results “Do we believe that we can grow our [upstream] business? In terms of cash, we have always said that it is value over volume. We do not have volume targets. But it is probably fair to say that 2019 was the high point when it comes to our oil production.”
Global oil and gas investment was already behind what was needed for future oil supply. Oil followers have seen an increasing number of analyst views that global oil investment is too low and there is a supply crunch coming. These increased warnings are not considered a 2021 or 2022 issue given OPEC+ is still >7 mmb/d cut back, Iran is expected to come back under Biden and possibly even Venezuela. This undersupply is not a new item. But the increased reduction of capital to oil and gas from European supermajors will only increase the underinvestment impact on future oil capacity additions. Our June 11, 2020 blog “Will The Demise Of Oil Take Longer, Just Like Coal? IEA and Shell Highlight Delays/Gaps To A Smooth Clean Energy Transition” [LINK] highlighted the IEA’s “Tracking Clean Energy Progress” update. The headlines were on how the IEA saw underinvestment in renewable was far below levels needed to meet Energy Transition timing and therefore overlooked the IEA also highlighting global oil and gas supply was also far below levels needed to meet future oil supply. Below is the IEA graph from the update.
IEA’s Estimated 2019 and 2020 Invested Vs Future Required Investment
Russia’s reminder that they are price takers at $45 Brent seems focused on US shale/tight oil and, more importantly, capital providers thereto. There can’t be any doubt that Russia wants to make sure US shale/tight oil production doesn’t come back before Russia and that is why they will manage oil lower to $45 Brent in 2021/2022. As noted above, Novak said “The second trend is about an excess of resources around the world as a result of technological advances, which will also lower the demand. So, based on the above trends, I believe that we need to concentrate our efforts on two areas: expanding the domestic market, on one hand, and expanding and diversifying our exports, on the other.” If we look at frac technology, there is more than the US (ie. also Argentina, Canada, maybe Saudi?) but the reality it’s the US. And we think particular to capital providers. We have to believe Russia picked $45 Brent bottom end as the price level (ie. low $40s WTI) that isn’t high enough for US producers and capital providers to move to a sustained big increase in drilling new US shale/tight oil wells ie. not just completing DUCs that have lower half cycle break even oil prices.
YTD US Frac Spread and Oil Rig Count vs WTI Price
Russia has a financial advantage to withstand lower oil prices ie. Brent $45. Novak’s comment $45 Brent works for them as it helps them accomplish their goal of restoring production while others can’t is a reminder that Russia is less dependent on oil. There are a lot of estimates that OPEC producers need oil prices way higher (generally above $70 to $80) to cover social programs, etc in government budgets. So OPEC countries generally want higher oil prices. Our Dec 25, 2020 tweet [LINK] reminded that Russia has a financial advantage in withstanding lower oil prices for the short and mid term. We tweeted “Remember RUS has a much lower #Oil price comfort level than #OPEC+ partners. See below excerpt SAF Group Dec 20 Energy Tidbits https://safgroup.ca/research/trends-in-the-market/ highlights oil is ~30% of RUS revenues and its net foreign assets keep increasing”, The tweet was based on two items. Our Dec 18, 2020 tweet [LINK] on Putin’s Dec 18 press conference and Russia vs Saudi Arabia net foreign assets ““ICYMI. RUS advantage Vs KSA in how it approaches #Oil markets/strategy – low #Oil price doesn’t impact as much. Putin reminded #Oil is ~30% of RUS revenues. KSA is ~55% in 2020 and normally much higher. KSA net foreign assets down ~$300b in 5 yrs, vs RUS up ~$150b.” Earlier today, there was an update to Saudi Arabia net foreign assets. Our graph below reflects the new data. But Saudi Arabia net foreign assets peaked in Aug 2014 at $737.0b, ended 2019 at $493.8b, hit bottom of $442.2b at April 30, was basically flat for 3 months before an increase of $5.3b to $448.6b at Aug 31. Net foreign assets fell once again in Oct, falling $0.9b to $441.9b but increased in Nov to $452.1b. This means Saudi Arabia has burned thru approx. $285 billion in the past 6 years or approx. $50 billion per year on average. Whereas Russia’s net foreign assets continue to modestly increase. We only have Russia data to Sept 30, but during this time foreign assets increased from $443.7b in Aug 2014 to $545.8b to end 2019, and are now up to $591.1b at Sept 30. This means Russia’s net foreign assets have steadily increased by an average of ~$25b per year over the past 6 years.
Russia Vs Saudi Arabia Net Foreign Assets (US$b)
If Russia says it’s a price taker at $45 Brent for 2021/2022, it gives visibility to a return to higher oil prices post Covid. We believe its important to look at Russia’s messaging and its impact from both a short and long term perspective that can, on the surface seem different, but in reality are linked. In our tweet this morning [LINK] we highlighted Russia plays a long game. Most importantly we see the logic to this strategy and that it gives them the best visibility to what they want – get production back to full capacity and maximize the value of its oil reserves in a world of lower future oil demand.
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Doesn’t mean Russia won’t agree to no increase at OPEC + Jan 4 meeting. We understand that a part of Russia’s comments are negotiating with its OPEC+ partners either for Jan 4 meeting or setting the stage for the next monthly meeting. Russia is clearing warning his OPEC+ partners that they want to increase production and importantly, why? They worry that higher prices will allow the US and others to restore production, and they think lower oil prices ie. $45 Brent are needed. They really want to manage to price. This in itself is not what OPEC+ ever says they do, they never say they manage for price. They manage for stable markets for consumers and producers. All Russia is clearly stating is that they need to manage to price to avoid others from restoring production before they do. We have to believe Novak is putting this position forward to OPEC+ for next week as a notice to the OPEC+ partners, this is what we need to do for 2021 from Russia’s perspective. However, we don’t think it precludes them from agreeing to no increase to OPEC+ quotas for Feb. Novak has consistently left himself an out as he says “If the situation is normal, stable, we will support the increase” but after the first two days of the UK variant said “Over these two days, the situation, in my opinion, has changed, it is changing quite actively.” Whether OEPC+ agrees to increase by 0.5 mmb/d or stay flat next week, we don’t think it changes the bigger Russia warning that a change in strategy is needed in 2021.
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Russia’s changing view on peak oil demand is driving the apparent big change in oil strategy if it wants to maximize value for its oil and natural gas reserves. No question that there are multiple Russian comments on net zero, energy transition and peak oil demand being a bigger risk ie. moving sooner. But the most telling comment that Russia really believe peak oil demand is happening sooner than expected and has to find a way to hurt post Covid oil supply only appeared in Russian, when TASS reported “In the coming decades, Russia needs to pay special attention to the monetization of energy resources: oil, gas and coal, as demand in developed countries may decrease. This opinion was expressed by Deputy Prime Minister Alexander Novak at the session of the “Russia and the World” project. “My opinion is that in the coming decades [Russia] needs to pay more attention to the monetization of existing reserves,” he said.” They are focused on how to monetize existing oil reserves.
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So Russia can be a price taker at $45 Brent in 2021/2022 as it likely sets an effective post Covid floor price for the 2020s. Russia plays the long game and realizes peak oil demand means they have to hurt other oil supply growth. European supermajors are already cutting oil and gas to shift that capital to renewables. That’s good timing for Russia. Their warning all other oil producers and their capital providers that it is a price taker at $45 Brent will help keep capital from flowing into oil and lead to another year or more of continued global oil underinvestment. And it means that post Covid (say post 2022), Russia’s $45 Brent price taking in 2021/2022 effectively becomes the floor price going forward.
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The Energy Transition is going to happen. No one should be surprised given the massive debt and economic crisis from Covid isn’t deterring this ambition, rather its leading to an increase desire for an accelerated Energy Transition. As the IEA has been highlighting all year, global investment is far below the needed levels for a timely Energy Transition. This means that it will be bumpy and not timely road to the Energy Transition and these gaps/bumps should lead to short term periods of oil price spikes over an effective $45 Brent effective floor.
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If Russia is successful and it means oil is a little lower in the near term, it may be hard to see in the next few months, but oil producers with the low cost reserves, financial support, capital provider support and have ability to see the other of side of Covid should hope Russia can be successful in a new strategy.