How oil prices impact Russia’s economy

  • Alican Tekingunduz
  • 29 Nov 2018

The Russian economy’s dependence on oil and gas exports makes it vulnerable to fluctuating prices.

Russian President Vladimir Putin, second right, during a visit to oil refinery in Kirishi, near St Petersburg on Friday, July 8, 2011. Refinery chief Vadim Somov is left, and Vladimir Bogdanov, Surgutneftegaz oil company president, stands to Putin's right. ( AP )

Russia is the second biggest oil exporter in the world, making its economy vastly dependent on the global oil market. Oil and gas exports constitute 40 percent of the total federal budget revenue of Russia. 

A dip in oil prices between 2014 and 2016 caused big losses to the Russian economy. 

The price of crude oil decreased more than 30 percent from $75 to $51 between October 2 and November 29. This is the first declining trend since February 2016, the lowest price level in the last decade. 

How vulnerable is Russia?

Russia is missing, or has already missed, the chance to transform how it generates revenue by investing instead on military expansion, economy consultant Yakup Kocaman told TRT World. The effect of Russia’s military expansion policy will be seen in the long-term, he said, commenting on the country's dependence on oil.

“The revenue from oil and gas is also very important for Russia as the country is carrying out military activities in several regions such as Ukraine, Crimea and Syria,” Kocaman told TRT World. 

Yet in May, when the Russian Finance Ministry announced the federal budget 2018-2019, it seemed economic prospects were looking brighter. 

The country’s estimated oil and gas revenue was revised from $8.5 billion to $44.4 billion. The estimated increase in revenue from oil and gas nearly equalled the increase in total revenue.

The country’s resilience is often credited to low oil production costs and a weakening rouble which allows for attractive exports. 

But oil trade, vital for Russian economy, is conducted in US dollars, a “monopoly” Russia’s President Vladimir Putin wants to end. 

"Certainly, we are thinking about what we need to do in order to get free of this burden,” Putin said in May. 

“Furthermore, our partners are helping us by introducing all these unlawful restrictions and violating principles of the global trade, because the whole world sees the dollar monopoly is unreliable; it is dangerous for many, not only for us," he said.

The top three crude oil producers — Russia, the United States and Saudi Arabia — will be at the G20 Summit this weekend, raising expectations that oil policy will be discussed. 

The Organization of the Petroleum Exporting Countries (OPEC) will meet on December 6 in Vienna to discuss output policy with some non-OPEC producers, including Russia. 

Why do oil prices fluctuate?

There are several factors that have an impact on oil prices: supply, market anxieties, political impact on trade, the use of technology in production and natural disasters.

Future contracts of oil trade among countries in any given price also can affect the market.

Investments on pipelines to transport oil reduce transportation costs together with the price of oil.

However, one of the most important determinants of oil prices is OPEC.

The OPEC-Trump tangent

OPEC is a consortium of 14 oil exporter countries: Saudi Arabia, the United Arab Emirates, Iran, Iraq, Kuwait, Qatar, Libya, Nigeria, Algeria, Angola, Ecuador, Equatorial Guinea, Gabon and Venezuela.

The consortium controls nearly 40 percent of the world’s total oil supply. The organisation sets production volume to meet the demand for oil in negotiation with countries outside OPEC, such as the US and Russia. 

If OPEC decides to increase production, prices can fall. If they achieve a coordinated cut, prices can rise.

US President Donald Trump asked Saudi Arabia, OPEC’s de-facto leader, this summer to raise oil production to compensate for lower crude exports from Iran after sanctions and to ensure no spike in oil prices before midterm elections. 

Saudi Arabia raised oil production to a record high in November, an industry source said on Monday, pumping 11.1 million to 11.3 million barrels per day (bpd). 

But the US also offered generous waivers to allies who imported Iranian crude and might have struggled to find other supplies quickly when US sanctions kicked in on November 4. 

This kept more Iranian crude in the market instead of driving exports from Riyadh’s arch-rival down to zero and bringing down the price per barrel to $51.18.

“Even if Russia and Saudi Arabia reach an agreement at the G-20 to decrease output,” other countries might respond by increasing their output, Kocaman said. 

The chart shows the cost of production of oil and gas per barrel for the countries by using data from Rystad Energy UCube and The Wall Street Journal.(TRTWorld)

Average cost of oil and production per barrel

Average cost of oil and gas production per barrel changes from country to country according to differences on capital spending, production cost, administrative and transportation cost and gross taxes.

Saudi Arabia benefits by drilling the cheapest oil in the world because of low capital spending and absence of gross tax on oil. The energy resources, pooled in vast oil fields, are near the surface of the desert. 

It costs the kingdom only $3.50 to pull a barrel from the ground. The average cost of oil per barrel for Saudi Arabia is less than $9 according to data collected by Rystad Energy in 2016

In Russia, nearly half the cost of production per barrel is gross tax —  $8.44 of the total cost of $19.21 per barrel, even though the production cost is $2.98, which is lower than Saudi Arabia’s.

Saudi Crown Prince Mohammed bin Salman, a key Trump administration ally, wants prices at $80 or more for his economic reforms.

When the Saudi crown prince —  as is expected —  asks Putin to cut down output in a bid to drive up oil prices, some speculate Russia could have the upper hand in the negotiations. Putin has reflected his comfort at oil prices hovering around $60 per barrel.

Yet Russia is becoming increasingly convinced it needs to reduce oil output in tandem with OPEC even though it is still bargaining with Saudi Arabia over the timing and volume of any reduction.

"We are in contact with OPEC, and we are ready to continue our joint efforts if needed," Putin said on Wednesday.