How serious a challenge will fallout from the coronavirus pose to Russias long-standing economic model, which remains heavily dependent on oil and gas exports? The first phase of the global pandemic and lockdown measures froze much of the economic activity around the world. In turn, energy demand dropped virtually overnight, and oil and gas prices plummeted.

The scale of the disruption was truly staggering. As a significant part of the global economy is starting to reopen in places like China, the United States, the European Union, and Russia, the key question for Russian policymakers is whether this shock should prompt a rethink about radically reducing Russias income from energy exports and the prospect of fundamental changes to global energy markets over the long term.

The global oil industry is undergoing the biggest crisis it has ever seen, thanks to an unprecedented 30 percent year-on-year fall in demand in April 2020. That drop led to a dramatic oversupply of oil in storage, which is part of the reason why West Texas Intermediate (WTI) oil futures prices in the United States briefly traded below $0 per barrel in April. Spot prices for Brent fell by 87 percent from year-end 2019 through mid-April 2020. (Prices have partially recovered since then, but are still down 50 percent as of end-May 2020.)

The so-called OPEC Plus group of leading oil-producing countries, which includes Russia, agreed on emergency production cuts to stabilize prices in early April. That agreement has started to pay off, and demand has started to recover somewhat with the understandable exceptions of important sectors such as aviation and U.S. domestic transportation. The leaders of OPEC Plus, Saudi Arabia and Russia, along with their U.S. counterparts, are now thinking through a complicated challenge: how best to avoid further turmoil in oil markets as some economic activity comes back online even though there is still great uncertainty about a possible second wave of the pandemic.

Still, it seems reasonable to expect that prices in 20202021 will stay far below $60 a barrel, which was the annual average price during 2019. Russian producers remain perfectly competitive even at lower price levels. However, we should not lose sight of the fact that during the Saudi-Russian price war just a few months ago, Urals crude fell to levels at which budget revenues were wiped out, new projects became unprofitable, and even current ones just barely made economic sense.

The gas industry has not experienced a comparable drop in demand during this crisis. The brunt of the pandemic-induced drop in demand has largely been concentrated in the industrial and commercial sectors, resulting in a 4 percent average annual global decrease, according to International Energy Agency estimates. In Europe, the gas market was oversupplied, and a buildup in storage facilities resulted in sharp declines in exports from countries like Russia and Norway. But globally the situation has been far less dramatic than the disruptions experienced by the oil industry.

For Russia, the turmoil in energy markets created a large reduction in export revenues, lower profits for energy companies, and reduced funding for the state budget. Even in the most optimistic scenario, oil export revenues will be approximately half of what they were pre-crisis. Its entirely possible that the picture will be gloomier still, with budget revenues in 2020 falling to a quarter of what was envisioned before the crisis. In an extreme scenario caused by a severe resurgence of the virus, the Russian oil industry could find itself teetering on the brink of operating at a loss, virtually depriving the state budget of revenues from export and extraction taxes.

The fallout is also already being felt by Russian gas exports, though their impact on the budget is far smaller. Judging by the results of the first quarter and the decrease in European demand, by the end of the year, deliveries of Russian pipeline gas to Europe may drop by 2530 billion cubic meters. The remaining deliveries will have to be supplied amid significantly lower prices. Market oversaturation, warmer weather, and ongoing lockdown measures will all drag gas prices in Europe down even further.

Were looking at gas prices halving and oil prices reducing by one-third. All told, that means a combined 2025 percent decrease in volumes of Russian exports of oil, gas, and coal, which is equivalent to a 50 percent loss of export revenues. For the budget, this means a sharp fall in income (of about 25 percent), just as the public and private sector are experiencing the greatest need for state support.

For fuel and energy companies, all of this will mean adopting strict cost-cutting measures and making cuts to capital investment programs, which will in turn impact other companies that serve the oil and gas sector. According to our calculations, this could lead to an additional fall in GDP of 513 percent in 2020 (on top of the 5 percent reduction in GDP caused by the coronavirus and lockdown measures).

Still, the current shocks faced by Russian energy markets, serious as they are, may pale in comparison to their potential long-term consequences. It is highly likely that the coronavirus crisis will amplify and accelerate trends for decarbonization, decentralization, and digitalization, especially in Europe, Russias main market. There are already increasingly vocal calls from governments and international organizations to adopt a low-carbon approach to getting the economy going again. The instability on the oil market only strengthens the hand of renewable energy, which is attracting increasing attention from investors.

Economic revival could follow the traditional trajectory, or it could take the form of an accelerated transition to other forms of energy. In the first scenario, low oil prices will spur demand for energy commodities, and demand will start rising again fast. Then the failure to invest during the crisis will make itself felt, leading eventually to higher oil and gas prices, which will in turn again revive interest in alternative energy sources and increasing energy efficiency.

In the second scenario, the state will make a more decisive choice in favor of green energy, which hands a significant advantage to sectors that compete with oil and gas. Energy-importing countries could come out of the crisis with transformed energy systems, strict carbon footprint restrictions on any imported raw materials, and permanently reduced demand for hydrocarbons.

In the current conditions, the Russian oil and gas sector must not only survive, but also think about long-term options for restructuring the entire industry and integrating hydrocarbons into the green agenda. A key role in this could be played by the trend for decarbonizing oil and gas: a complex, expensive process that requires new technologies and skills that Russia currently doesnt have. For now, however, there are no other options in sight for securing the long-term stability of Russias export-focused resource-based economy.

Also on Carnegie.ru:

Russia and Ukraine in the Age of Coronavirus,Konstantin Skorkin, July 08, 2020.

RussiaU.S.: No Reset, Just Guardrails, Dimitri Trenin, July 08, 2020.

Western Sanctions on Russias Oil and Gas Sector: a Damage Assessment, Tatiana Mitrova, July 25, 2018.

Photo by Kiril Aristov shared in the public domain.

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The Oil Price Crash: Will the Kremlin's Policies Change? - Russia Matters