Why Russia’s energy leverage in Europe isn’t likely to last

Iraq’s oil boom may be a bust for Vladimir Putin.
Iraq’s oil boom may be a bust for Vladimir Putin.
Image: Reuters/Essam Al-Sudani
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Some have suggested that the US ought to unleash its “energy weapon” against Russia, speeding up its oil and gas exports to undercut Moscow’s ability to use its vast reserves to stampede Ukraine. But a number of analysts say that’s unnecessary—the market itself already presents a threat to president Vladimir Putin.

You wouldn’t know it by current oil prices. Traders bid the price of the global Brent benchmark over $108 a barrel today on a perceived risk to Russian oil exports. The global market relies heavily on Russia, which pumped 10.53 million barrels a day in February, of which about 7 million barrels a day was exported in the form of crude oil and refined products.

But in a piece (paywall) over the weekend, Barron’s led with the headline “Here comes $75 oil.” The publication went on to forecast that, because of a burst of new supply from the US, Iraq, and elsewhere—in addition to muted demand, added energy efficiency, and alternative fuels—oil prices will make that 30% plummet over the next five years.

If accurate, the plunging prices would devastate many oil-producing states, including Russia. Oil and oil-indexed natural gas exports account for half of Russian state budget revenues and some three-fourths of the country’s exports. The Russian budget requires an oil price of $117 a barrel to break even, according to estimates.

What happens next?

Underlying the Barron’s forecast is a debate. Are we living in a new age of energy abundance and cheaper oil? Or is the current oil and gas boom a mere blip that will eventually give way to a long-term continuation of higher and higher prices?

Many industry players say it’s the latter. In a March 27 note to clients, Bernstein Research said that energy investors surveyed by the firm expect oil prices to remain basically where they are through 2016. In early March, Chevron CEO John Watson said the company expects a long-term average oil price of $110 a barrel based on the cost of production. Such thinkers foresee a full circle—oil prices will drop, forcing financially minded drillers to curb production, leading to a tighter global supply, and again triggering high prices.

But a growing drumbeat of analysts say the fundamentals have changed. Much lower prices are ahead, they assert.

For starters, Citi’s Ed Morse challenges the circular theory of oil prices—even if prices drop to $75 a barrel, some drillers, particularly state-owned companies whose motivations are not so simple as pure profit, will step in and keep producing, Morse says. He forecasts an age of cheaper energy lasting for a half-century or more.

A paper published by Rice University last summer argues similarly that, short of war in or near a big petroleum-producing state such as Iraq, oil prices will fall “precipitously” from 2016 to 2018. Amy Myers Jaffe, one of the paper’s authors, argues that production costs are not static—when oil prices drop, production costs fall with them.

Neil Atkinson of Lloyd’s List Intelligence says that the fundamentals already support a drop in prices—the global growth in oil demand this year will be lower than the rise in supply, he says.

A boom in the fields

The data these researchers cite include US production, where the frenzy in the US shale patch continues to build. Drillers are using a record 1,487 rigs to produce oil in Oklahoma, North Dakota and south Texas, according to the Baker Hughes rig count. Two weeks ago, the US produced its highest volume of oil in 26 years at some 8.2 million barrels a day—4% higher than the average of 7.8 million barrels a day pumped in the fourth quarter last year.

Then there’s Iraq. Last month, Iraq produced about 3.6 million barrels of oil a day, a 35-year high. Over the weekend, Lukoil began a flow of 120,000 barrels a day of production at its West Qurna-2 field, suggesting that the country will set a new contemporary record in March. If production hits an Iraqi government target of 4 million barrels a day by the end of the year, the country would be exporting 3.3 million barrels a day, delivering a wallop to OPEC—and Russia. To do so, Baghdad will have to reduce tensions significantly with northern Kurdistan, which last year stopped sending its oil through the national network in a dispute over the income it receives for the crude. But friction already appears to be dissipating.

Coming up fast behind these boom states is a forecast boost in Mexican oil production starting in the 2020s.

There is no knowing if the price bears are right. But if they are, the safer bet for the US is to maintain the current course and unsheathe no purported energy weapon. Shale, Iraq and Mexico are all the arms required.