Falling hydrocarbon prices will cut budget revenues by 30%

Tatyana Mitrova, director of the energy center at the Skolkovo Moscow School of Management, writes about what awaits the Russian economy after the pandemic in a situation where business activity and demand and prices for energy are collapsed.

The expert notes that the world oil industry is experiencing the deepest crisis in its history: oil demand fell by an average of 10% this year, and this, with oversupply, led to an unprecedented imbalance. The energy price fell 3.5 times, and futures for the first time in history sold at a negative price.

OPEC + countries and those that are not members of this coalition have agreed to cut production by two years by 8.2 million barrels and 5 million barrels per day, respectively. This may be enough so that the storage is not crowded and prices no longer fall, but that’s all. Now it’s obvious that prices will not return to the pre-crisis level in 2020–2021, remaining at $ 30 per barrel or lower.

In addition, oil companies will reduce costs and conserve wells, and therefore investment in oil production will fall by 45%, which can then lead to a shortage of oil in the market ...

This war of prices leads the oil industry in Russia to the fact that the Russian budget revenues will become practically zero, new projects will be unprofitable, and old ones will remain on the verge of profitability.

To get out of the situation with the least losses, Russia will have to either freeze for a while or seriously alter the tax, licensing and other regulation of the industry.

As for gas, here the situation is somewhat better. While the reduction in demand for it fluctuates in the world at the level of 3-5%. That is, there will be no cataclysms similar to the oil one, although a drop in gas demand in Europe and the filling of storage facilities can provoke the same situation. The whole question is who will reduce supplies: those who produce network gas or LNG, and whether they can agree among themselves on the example of OPEC +?

Although the risk that the timing of gas projects (pipelines, LNG plants, production) will be extended due to the pandemic is quite high. And there, existing agreements can already be revised and the conclusion of new contracts can stop altogether - something similar is already happening in Asia with reference to the coronavirus.

All these events mean for Russia a very strong drop in export earnings, revenues from oil and gas companies and budget revenues. In the best case, the proceeds from the sale of oil will decrease by 2.5 times, and in the worst - by 4-10 times this year. Moreover, the industry will be on the verge of breaking even, which will deprive the budget also of money from export duties and production taxes.

This is already happening with gas exports, although it affects the budget less. Russian gas supplies to Europe will be reduced this year by 25-30 billion cubic meters, and those that remain will be produced at prices significantly lower.

All this, together, will lead to a drop in budget revenues by about 30%, and at the very moment when ordinary citizens and entrepreneurs urgently need state support. These losses are comparable in volume to the entire National Welfare Fund, and therefore it is not clear where to look for financing programs to stimulate the economy after the crisis. All this will lead to a new decrease in Russia's GDP by 5–13% this year.

Long-term consequences will be even worse. It’s not even a matter of competition with other oil and gas producing countries, but the fact that a pandemic will inevitably raise the question of strengthening and accelerating the decarbonization, decentralization and digitalization of the world economy, and, which is especially painful for Russia, especially in Europe. The instability of the oil market is forcing the West to strengthen the renewable energy sector through new investments.

There are two scenarios. The first implies that low oil prices will stimulate demand for hydrocarbons, but as soon as the market experiences a crisis of investment failure, oil and gas prices will rise, which in turn will revive interest in alternative energy sources.

The second scenario implies an accelerated transition to green energy with enormous state support, with a quick and irrevocable reduction in hydrocarbon demand.

Whether the Russian oil and gas sector can get out of this situation, begin restructuring the industry in order to integrate hydrocarbons into the green agenda through decarbonization of oil and gas is a very big question. There are no such technologies in Russia yet, but there is no other way out for an export-oriented raw material economy either.