Russia threatens future of Opec

THERE was a time when Opec could regulate global oil prices simply by turning its taps on or off. Prices falling? Tighten the taps to restrict supply. Rising prices scaring off customers? Open the taps to let more oil flow to market. But now the cartel's freedom is being increasingly threatened by a non-member, Russia.

Russia is now the world's third biggest producer behind Saudi Arabia and the US. It accounts for 9% of the world's oil output, with daily production climbing to over 7m barrels this year.

This compares with the 29.5m barrels a day flowing from the taps of Opec's 11 members - Saudi Arabia, United Arab Emirates, Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar and Venezuela. Opec met at the weekend, approving plans to cut back their combined production by 1.5m barrels a day, representing nearly 2% of the world's output. However, the Russian oil industry is clearly big enough to limit the cartel's room for manoeuvre.

This is potentially good news for consumers, of course. The increasing production from non-Opec countries is leading many analysts to downgrade their longer-term forecasts for oil prices by up to 30%, a fall which should eventually reduce petrol prices. But the outcome depends on how successful Opec is in persuading Russia to toe the line.

The cartel's pleas to Russia started in early October, when oil prices fell from more than $30 a barrel to less than $20 after the 11 September attacks on the US. Russia offered to cut its output - but only by 30,000 barrels a day, a move greeted with disgust within Opec.

In retaliation, Opec said that if Russia, as well as fellow non-member Norway, were unwilling to make a realistic cut, then the cartel would not implement its own proposed reduction of up to 1.5m barrels a day. Russia subsequently agreed to slice its oil exports by 150,000 barrels, but only for the first quarter of next year. Opec accepted this, saying it was sufficient to convince its members to implement their proposed cuts.

The cartel has two motives for its pressure on Russia: first, of course, it simply wants to retain its ability to raise prices. But secondly, it wants to involve non-members in the process in order to deflect the criticism customers will inevitably level at producers.

Indeed, some analysts believe the argy-bargy with Russia has so far amounted to little more than a global public relations stunt for Opec. Dr Leo Drollas, head of the London-based Centre for Global Energy Studies, says Russia's exports would have fallen by the agreed amount over the winter anyway as increased domestic demand for heating fuel kicked in.

Russia can also get around the lower export quota, which says nothing about how much it is allowed to produce, by selling more of its oil as refined products, a tactic which will ultimately put pressure on the price.

The fact is, the Russian government can do little to stem the flow through the country's ever-expanding wells. About 90% of its production is now in private hands and government influence is limited to issuing export licences.

'Opec is clutching at straws in the wind,' said Drollas. 'They want a commitment from Russia so that they can cut production themselves and then claim they have the support of non-Opec producers. People in the oil business know this game but Opec wants the support of the world so that it can deflect criticism of high oil prices.'

Drollas says Opec's obsession with targeting Russia has grown since the attacks of 11 September. 'Given the current economic climate, it does not want to be seen to be kicking somebody when they are down.'

However, Colin Lothian, an oil analyst with Edinburgh energy consultants Wood Mackenzie, said there is some justification for Opec's concern about Russia's growing influence in the oil market. The weak prices endured in 1998 and 1999 prompted Russian oil companies to send much of their profit overseas, rather than using it to fund exploration or to expand existing operations. But they are now ploughing much of their earnings into the hunt for new fields, ensuring there are enough fresh finds to more than offset current production.

Lothian says the Russian government is targeting a rise in production of 36% by 2005, though he believes this is highly ambitious. 'To increase it to the levels they are forecasting will require significant investment,' he said.

He believes some of Opec's fears over Russia stem from knowing there is little this rapidly emerging producer can do to cut production because the high water content in the production facilities will freeze and break if the flow stops.

That Russia continues to produce as much as it can while Opec has almost 20% of its capacity sitting idle is a source of much aggravation within the cartel. Saudi Arabia, America's greatest ally within Opec, accounts for half of this.

Drollas says the growing influence of non-Opec countries means the cartel has to either lower its price target of $22-$28 a barrel to between $18 and $20, or accept that it will become an increasingly irrelevant force in the oil market.

'The fact is Russia is going to keep investing in new production because it can make money at $20 a barrel,' he said. 'So the pressure put on Russia by Opec will become greater.' Consumers will, of course, be hoping that Russia resists the pressure.