WILL RUSSIA JOIN OPEC?

C O N F I D E N T I A L SECTION 01 OF 03 MOSCOW 003649

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E.O. 12958: DECL: 11/21/2018
TAGS: EPET ENRG ECON PREL RS
SUBJECT: WILL RUSSIA JOIN OPEC?

REF: A. MOSCOW 2774

B. MOSCOW 1295

Classified By: DCM Eric S. Rubin for Reasons 1.4 (b/d)

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SUMMARY
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1. (C) President Medvedev recently fed speculation about
Russia's intentions to cooperate with or join OPEC, telling
the press on December 11 that Russia "must defend" higher oil
prices, including by reducing oil production and, possibly,
joining "organizations of producers." Most Moscow-based
analysts dismissed the possibility of Russia formally joining
OPEC and giving up its sector independence. They also
pointed to the legal and technical hurdles production cuts
would face: much of the industry is nominally in private
hands and Russia's oil fields could not be easily shut off
(or brought back online).


2. (C) However, these same analysts said the GOR could take
credit for lower Russian production by continuing its current
policies, especially its onerous tax regime, which has
already lead to declining production in 2008, with greater
losses forecast for 2009. In that regard, we believe the
most likely scenario for the upcoming OPEC meeting in Algeria
is that Russia will announce some type of informal
cooperation with OPEC, commit to reducing production by up to
a few hundred thousand barrels per day (bpd),and "fulfill"
that obligation by doing nothing to reverse the projected
declines in the coming year. End summary.

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RUSSIA FLIRTS WITH OPEC
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3. (C) In a departure from a past insistence on Russian
independence with regard to oil policy, Russian leaders have
recently made various statements with regard to "cooperating"
with OPEC. Whether serious or aimed merely at raising
uncertainty in order to spook markets toward higher oil
prices, President Medvedev on December 11 went as far as
suggesting to the press that Russia should consider joining
"organizations of producers" in an effort to "defend" higher
oil prices, which he admitted are critical to the Russian
economy.


4. (C) Earlier, on September 9, Deputy Premier Igor Sechin,
overseer of Russia's energy sector and policies, attended an
OPEC meeting in Vienna, reportedly agreeing to "share
information" with the cartel. Energy Minister Sergey Shmatko
said on December 10 that Russia expects OPEC members to
reduce production significantly at the upcoming meetings on
December 17 in Algeria. He added that Russia will present
"concrete proposals" at the meetings regarding its own
posture.

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BUT UNLIKELY TO JOIN
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5. (C) Despite this recent rhetoric by GOR leaders and the
many high-level meetings between GOR and OPEC representatives
(ref A),most analysts don't believe Russia would go so far
as to formally join OPEC. Joining OPEC could result in an
intolerable loss of independence for a Russia that prides
itself on control over its natural resources and over
decisions regarding the all-important energy sector.
Furthermore, Russia's oil sector, unlike in other OPEC
members, is not nationalized. More than half of production
is nominally in private hands, albeit under indirect Kremlin
influence.


6. (C) Vladimir Konovalov, head of the Petroleum Advisory
Forum, the association of major Western oil companies in
Russia, told us December 12 that Medvedev's words are likely
just rhetoric, said with the aim of buttressing oil prices,
but without any intention of a formal commitment to become an
OPEC member. Analysts from several investment banks echoed
similar sentiments in their daily newsletters or were quoted
in the press with similar analyses, noting Russia's long-held

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position of the importance of its independence in the oil
market. (N.B. If Russia is planning to join OPEC, it must be
news to the Algerian Embassy, which called us on December 16
to ask if we had an updated phone number for the Russian
Ministry of Energy as they needed to call the Ministry to
discuss the upcoming visit.)

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FORMAL PRODUCTION CUTS ALSO UNLIKELY
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7. (C) Even if Russia decided to cooperate with OPEC on a
production cut, the question remains as to the mechanics of
implementing such a directive in Russia. The possibilities
include "voluntary" cooperation by all Russian producers -- a
cartel within a cartel -- or "technical" restrictions on the
part of Transneft, the state-owned Russian oil pipeline
monopoly. Smith agreed that if the GOR were to decide on a
formal policy of lower production (which would be a break
from numerous public calls by the highest levels of the GOR
for increased Russian production),they would have to rely,
in the short-term, on "informal measures," suggesting
political pressure or administrative restrictions.


8. (C) Another hurdle to production cuts is the physical and
technical limitations of the Russian industry. Unlike Saudi
Arabia, for example, Russian oil production cannot be easily
ramped up or scaled down. There is no "spare production
capacity." As one oil analyst recently wrote, many Russian
wells in West Siberia (the main producing region) cannot
easily produce again once they are shut off. A GOR mandate
to curtail production would not easily be reversed if more
production was again desired given different
economic/financial circumstances.

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HOW RUSSIA COULD "COOPERATE" ) BY DOING NOTHING
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9. (C) There may very well be good reason, however, for
Russia to "cooperate" with OPEC. Ron Smith, chief strategist
at Alfa Banks, shared with us on December 12 an internal
analysis demonstrating large potential financial gains to the
GOR under a scenario of coordinated production cuts resulting
in substantially higher oil prices. Other analysts are more
skeptical, noting individual OPEC members's track record of
failing to follow through on production cuts. In addition,
higher prices that result from restricting supplies might
cause demand to fall even further, reducing sales and
revenue.


10. (C) A widely held view among energy sector watchers in
Russia is that the mechanism by which Russia would contribute
to an OPEC production cut would be to do nothing, especially
to its oil tax policy that retards upstream investments (ref
B). This view is supported by Chevron Russia President
Darrell Cordry, who opined that Russia may just be going
along with OPEC as means of disguising the current decline in
production as a deliberate government-imposed reduction. Due
largely to an onerous tax regime that imposes severe
disincentives to investment in new production, Russian oil
production will decline slightly in 2008 for the first time
in nearly a decade. Production is expected to decline
further in 2009, perhaps by up to 5%, or approximately
500,000 barrels.


11. (C) Konovalov told us he has long-believed the GOR's
reluctance to move forward reform of the tax structure --
toward a system based on profits instead of production -- was
part of a deliberate plan to keep a lid on Russian production
in order to support higher global oil prices. He said
cooperation with OPEC "will now give them cover" to do what
the GOR wanted to do all along, which is to continue
rent-seeking behavior in the sector through high, even
confiscatory taxes on the sector.


12. (C) Rosneft Vice President for Finance, Peter O'Brien
(strictly protect),also thought delaying tax reform would
amount to deliberate action to lower potential production in
the medium-term. He told us December 14 that the GOR had
been very close to implementing a new tax regime on the oil
sector, but that it will now delay such action as its

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contribution to proposed OPEC production cuts. He said if
the GOR agrees with OPEC to cut production, it would
voluntarily delay projected future production increases by
holding back on planned tax cuts for the oil sector. (Note:
Sechin, who will head the Russian delegation to the OPEC
meetings in Algeria, is also Rosneft's Chairman. End note.)

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COMMENT
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13. (C) We believe the GOR will agree in Algeria to "reduce"
Russian oil production by a few hundred thousand barrels in
2009, a meaningless commitment since it is the probable
outcome regardless of any specific GOR action related to
OPEC. However, this will probably be touted by the GOR,
OPEC, and many watchers as signaling a new era of Russian
cooperation with OPEC, and could result (depending on the
size of the announced OPEC cuts) in a temporary spike in
crude oil prices.


14. (C) The impact, however, will be more psychological than
real. The supply and demand picture, and hence the global
price, will not be altered by Russia's announcement (and
maybe not by OPEC's according to the analysts with whom we
talked). Prices will likely continue to trend downward
absent a recovery in global demand or an unexpectedly large
and enforced OPEC cut. As to Russia's formally joining OPEC,
we also think it unlikely. That said, we add a caveat
Konovalov used with us -- we wouldn't bet too much money on
that assessment.
BEYRLE