Time consistency and the economics of Russian oil

by on March 25, 2016 at 12:39 am in Current Affairs, Economics, Political Science, Uncategorized | Permalink

The status quo ex ante seems to be unraveling:

“The oil companies are not investing at all in exploration of new deposits because profits on these projects will only come in 10 years. Nobody will invest in these projects.”

Of course the Russian government may end up resorting to an expropriation.  So why invest? But that seems to make the need for an expropriation all the more urgent:

There is little doubt that Russia needs the money now, and that the oil companies provide an enticing target. Because they are paid in dollars but conduct their domestic business in the battered ruble, Russia’s oil majors have lots of cash. While globally most oil companies are deep in the red, cash reserves industrywide in Russia remain at an estimated $90 billion, a deep and tempting pool for the strapped Kremlin.

Yet this is exactly the worst time for trust to collapse:

…oil deposits discovered and developed in Soviet times are nearing depletion. The country’s oil future, like that of the United States, lies in offshore and shale projects that are more expensive to develop.

Do not expect a stellar outcome:

A study leaked from the Ministry of Energy, seen as allied with the oil industry, and published last week in the business daily Vedomosti, presented a doomsday scenario. Russia, the analysis predicted, could cease to be an oil power, with output plummeting to half the current level by 2035.

It is always interesting to look at past history:

It would not be the first time oil entered a spiral of declining volumes and rising demands from the state. Short of cash in an oil price downturn in the late Soviet period, the Kremlin squeezed the oil industry. It was deprived of capital, at the time, for such things as imported machines.

Output in what is today the Russian Federation fell to about 8.8 barrels in 1991 from about 11 million barrels a day in 1988…

Here is the NYT piece by Andrew E. Kramer.

1 AIG March 25, 2016 at 1:00 am

Oil price collapse probably played an important role in the collapse of the USSR. Hopefully, this time it will play a role in the collapse of this latest Russian flirtation with dictatorship (which will likely be followed by yet another, but that’s to be expected)

2 Jan March 25, 2016 at 5:56 am

Oil was by most accounts the largest factor in the collapse. Reagan’s legacy was helped tremendously by the timing of the decline of oil prices. This despite the fact that Reagan actually sent Bush to Saudi to beg them to decrease production and bring oil prices back up, as the US oil industry was hurting at the time.

3 AIG March 25, 2016 at 4:47 pm

If only Republicans and crazy conservatives had understood this. Instead, they attribute everything to Reagan’s stern and harsh words. Not understanding the role of oil in both propping up the USSR and propping up Putin, they launched themselves into a ME debacle which increased oil prices for a decade, causing the very thing they claimed to have been responsible for defeating: a dictatorial militaristic Russia.

4 prior_test2 March 25, 2016 at 2:25 am

Thankfully, Saudi America will be able to step into the breach.

Or not, as the case may be – https://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=WCRFPUS2&f=W

5 MOFO March 25, 2016 at 9:39 am

Wut?

6 Ronald Brak March 25, 2016 at 3:26 am

China does not want to be in a position where they will have to pay $147 a barrel for oil again. And they are taking steps so they won’t have to. China currently has more electric cars than any other nation. They have over 100,000 electric buses and BYD produces them for export. And around the world the production of electric vehicles is increasing and the cost of batteries is falling.

Oil prices are going to rise. The depletion currently occurring in existing oil fields, combined with the dearth of new exploration and drilling guarantees that. But as oil prices rise we will see demand destruction occurring as ground transport becomes steadily more electrified. So apart from disruption in supply resulting from violence or natural disaster, I don’t expect oil to ever go above $147 dollars again as measured in current dollars, and it may not even go above $100. It is certainly quite possible for it to go above $100 but that would result in rapid growth in electric vehicle use and it probably wouldn’t be too long before the price of oil was on a permanent downward trend.

So money used to expand Russia’s oil production capacity now may not be money well spent.

7 AIG March 25, 2016 at 5:19 am

“China currently has more electric cars than any other nation”

That depends on the definition of a “car”. What passes for cars in China, is what we call golf carts in America.

By that definition, America has more golf carts than any other nation.

PS: How is electricity produced?

8 Ronald Brak March 25, 2016 at 5:42 am

The Chinese electric cars are not golf carts. Nor are they equivalent to US Neighborhood Electric Vehicles if that is what you are referring to. Chinese electric cars are of lower performance than Leafs and Teslas and others available in rich countries and generally aren’t as advanced technologically. This is because China is not rich. Yet.

With regard to your question about electricity, it is not produced from oil. It is instead generated from cheaper sources, the large majority of which are domestic in China. There has been a dramatic decline in Chinese coal imports over the past two years.

9 Nathan W March 25, 2016 at 10:04 am

In fact, coal-fired generation is entering into a period of overcapacity in China and a fairly large number of plants are slated to be shuttered over the next couple years. Increasing energy efficiency is one of the factors involved, and presumably declining production in some high energy intensity manufacturing- and construction-input industries is playing a role. The government plans to decrease the coal share of electricity from about 70% now to a bit over 60% in the medium term. Unlike most countries, the claims can be taken rather credibly because the government can exert more influence over the decisions.

10 AIG March 25, 2016 at 4:38 pm

“With regard to your question about electricity, it is not produced from oil. It is instead generated from cheaper sources”

Like, natural gas?

11 Ronald Brak March 25, 2016 at 9:30 pm

AIG, only a few percent of the electricity in China is produced from natural gas. And an increasing portion of that gas is produced from coal. For example, Queensland’s LNG exports to China are almost all derived from coal seam gas, with much smaller portions from fracked coal seams and conventional natural gas.

12 Axa March 25, 2016 at 9:27 am

Just looked for those BYD buses. Look great, can be a good solution to minimize PM10 pollution in urban areas. However, China is growing fast. At best (very optimistic best), electric vehicles will make their oil demand go flat. However, China oil demand going to lower levels than today before 2035 is completely unexpected. Oil companies are betting on China having the same level of oil demand as the US by that time.

I’d like to believe you’re right, less pollution, yeiiiii…..but, oiln consumption trends don’t look like that.

13 Nathan W March 25, 2016 at 10:09 am

Since China basically imports all of its oil, China has very different incentives than the US in setting oil-related policy decisions. (Well, market theory tells usthe incentives should be identical, since the US could export any surplus resulting from alternative uses, but for some reason that I truly don’t understand clearly – oil co lobbying? but why would they care if selling to domestic or foreign markets? Is the transportation margin that high? – this isn’t how it actually plays out.

Non oil producing countries tend to deter oil consumption and promote alternatives to a much greater degree than oil producing countries.

14 Ronald Brak March 25, 2016 at 11:16 am

China doesn’t have to reduce their oil consumption to avoid paying high prices for what they import. If, after a further period of adjustment, they manage to hold their oil consumption steady they can rely on decreased oil use in developed countries to keep a lid on prices. Oil use in developed countries has been trending downwards for years. But once China manages to stop its demand growing, oil consumption is likely to continue to decrease as the cost of the electrification of transport will continue to fall. Once electric cars are competitive without major subsidies through a combination of declining cost and increased oil prices their rate of production will only accelerate. Hence my prediction that we are headed for one more period of higher oil prices, but it will be the last.

15 AIG March 25, 2016 at 4:41 pm

“Just looked for those BYD buses”

I’ve got news for you and Ronald: electric buses have been used since around 1890 something. They used to be called trams back then. Then they removed the rails at some point in time in the 1950s, and put wheels on them, but they still ran on electricity.

I take it you’ve never been to any European city and wondered what those cables hanging over the roads are.

So, yeah, this is about as insignificant as it gets. A usual, investing in last century’s technology.

16 Ronald Brak March 25, 2016 at 9:45 pm

AIG, Australia is one of the most tram-tastic nations in the world. Here in Adelaide we only have one line that survived, from the beach to the center of the city, but Melbourne makes up for that with the largest and most extensive tram system in the world. It is just one of history’s little jokes that the worlds largest electric tram system ended up in the city with the most carbon intensive electricity in the developed world.

But Melbourne still has fossil fuel powered buses and electric ones will be a useful replacement for them. First the diesel buses and then our cleaner and longer lasting Compressed Natural Gas (CNG) ones. Electric bus adoption may be a bit retarded here as Australia is the world leader in CNG buses per capita, but we have a New Zealand produced electric bus that has been trialed for some time here in Adelaide, and a Melbourne electric bus that was made in China recently drove 1,018 kilometers on one charge.

17 chuck martel March 25, 2016 at 6:43 am

“There is little doubt that Russia needs the money now….”

All governments have an insatiable demand for money. But, according to Keynes and the MMT people, being sovereign, Russia can simply print more money or enpixelate it. Parenthetically, what’s with the obsession with keeping some prices high? Oil and housing, in particular. Isn’t one of the objects of human economic behavior to obtain scarce resources at the minimum cost? For instance, potable water produced from sea water has been prohibitively expensive in the past. Maybe it should be even more expensive. Would that make economists happy? If homeowners spent 88% of their income on mortgage payments and interest would that be a really good thing? Should bananas be $5/pound? Why doesn’t the state charge $20K for car license plates and solve some of their pension problems?

18 Dotplot March 25, 2016 at 2:22 pm

yes, potable water made from sea water should b more expensive, as should river, spring, aquifer, and lake water in SW US

19 tokarev March 25, 2016 at 7:44 am

Russia has a super low debt-to-GDP ratio but they can’t borrow the cash they need due to the western sanctions. So… let’s get rid of these stupid and harmful sanctions. Russia is a poor country, after all.

Unfortunately for the planet, it seems oil is going to stay quite cheap for the foreseeable future because US shale can resume large-scale drilling as low as $50/barrel. There are still technology improvements to be realized in tight oil production like better data analysis and walking rigs.

20 collin March 25, 2016 at 9:30 am

Weren’t the sanctions limited in scope and due the Ukraine/Crimea debacle? My guess is if Russia needed capital, they could find it in the global markets. China has a lot of capital. Of course with low oil prices and the Russian, would you want to lend them money (or large Russian companies) right now? Realize if the Russian loans go sour, unlike say China/Valenzuela, there are no military options to protect your capital.

For the greatest lesson of the Russian economy is if you start even small wars, it will hurt your economy and your government.

21 Lord Action March 25, 2016 at 2:51 pm
22 Jan March 25, 2016 at 2:46 pm

Is that mainly because of the sanctions, or because the interest rates to borrow would be so high due to Russia’s poor institutions and economic outlook?

23 collin March 25, 2016 at 2:54 pm

Both!!! And the companies would have little recourse outside of the Russian courts.

24 AIG March 25, 2016 at 4:42 pm

“let’s get rid of these stupid and harmful sanctions”

Hmm, they’re supposed to be harmful.

25 Govco March 25, 2016 at 11:14 am

Couldn’t happen to a nicer country

26 AIG March 25, 2016 at 4:43 pm

+ infinity

27 C March 25, 2016 at 11:46 am

Anyone else suspicious of the statements about Russian oil reserves running out? If I were an oil producer right now I’d be telling everyone that I was a month away from selling my last barrel.

28 Ronald Brak March 25, 2016 at 1:02 pm

C, we can be confident that Russian oil production will decline in the future. This is because at current prices new oil wells aren’t being drilled while current oil fields are being depleted so a decrease in output is inevitable, or at least it is without a rapid increase in price. Regardless of how honest those involved are about the details, the overall situation is one of decreased future production.

29 jorgensen March 25, 2016 at 2:25 pm

Western companies would have to be out of their minds to invest in Russia. Their money will be stolen and their executives will have a high risk of being imprisoned or murdered.

30 spencer March 25, 2016 at 4:23 pm

By way of comparison the number of rigs drilling for oil in the US has fallen from a peak of 2,014 in 2014 to
some 372 on 24 March 2016.

But maybe we should not make such comparisons of the US and Russia.

31 AIG March 25, 2016 at 4:44 pm

By way of comparison, US production has only decreased slightly, despite so many rigs being out of operation. US is now #1 producer of oil in the world. What does that tell you?

32 chuck martel March 25, 2016 at 5:26 pm

Drill rigs drill and complete wells. Then they leave and oil is produced after they’re gone.

Russia is a huge country. There’s probably lots of oil there that’s yet to be found.

33 Tom Warner March 25, 2016 at 10:42 pm

Good NYT piece. I think the point is that unwillingness to invest deprives the oil companies of a defensive argument against a tax aimed at stripping them of their cash. It doesn’t have anything to do with why the Kremlin would “need” to expropriate, which is to fund war and black budget.

34 Machees March 26, 2016 at 2:01 pm

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35 Ronald Brak March 28, 2016 at 12:31 am

I’ll mention that India is also into reducing its need for oil. Piyush Goyal, India’s Energy Minister, has announced India’s vehicles will be 100% electric by 2030.

http://economictimes.indiatimes.com/industry/auto/news/industry/india-aims-to-become-100-e-vehicle-nation-by-2030-piyush-goyal/articleshow/51551706.cms

An impressive goal but one I expect to be substantially reached, as currently India only produces roughly 20% of its own oil consumption.

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