Does Exxon’s Departure From Russia Signal Higher Oil Prices?

Exxon no longer has operations in Russia following what they (and most lawyers, I suspect) term an ‘expropriation’ of their 30% ownership share of Sakhalin 1 oil and LNG project, which produced nearly a quarter million barrels a day in 2021 plus about 700 bcf of natural gas. The company has been involved with Russia for many years and had been pursuing a possible shale oil project as well as considering investing in the Shtokman-1 supgergiant gas field in the Barents Sea. That latter field, one of the world’s largest, has been a frequent bridesmaid but never a bride: the size attracts investors but the extreme operating conditions have deterred them.

Exxon, like other oil companies, was in Russia pursuant to the Willie Sutton rule, “That’s where the oil is.” Although data on Russian oil resources is somewhat less reliable than for many other countries, the presence of supergiant oil and gas fields is an indicator that the undiscovered and undeveloped resources remain the largest conventional supply outside the Middle East. For years, it has defied the resource pessimists’ insistence that it was near a peak as well as the Western bias that they needed foreign technological assistance to operate. In fact, the Communist Soviet government managed to produce enormous quantities of oil and gas, despite the warped economic system (and sometimes because of it, albeit never optimally). Foreign tech has certainly helped but not been crucial.

Although Exxon’s exit means Russian oil production will take a hit, presumably U.S. drivers will not find gas stations with signs indicating their tanks are empty because Exxon lost its Russian supplies. That does not mean, however, that the nationalization will have no effect on markets. Most immediately, fields such as Sakhalin (in the Sea of Okhotsk) are far more difficult to operate than those in other parts of Russia such as Western Siberia. Exxon and its partners had relied on western oil field service companies and equipment in its operations, although ownership of the rigs after expropriation is not clear.

The lack of such equipment could mean a decline in output from the fields that comprise Sakhalin-1, but the amounts will be trivial on a world-scale. Operations elsewhere in Russia might similarly suffer from lack of western engineers and equipment, and Russian production might decline by 3-5% next year as a result, possibly more depending on the impact of sanctions. So far, the Russians have managed to find new buyers for their oil, and that should continue, regardless of existing sanctions. If the market is tight, then prices will receive at least a minor ($3-5/barrel) boost from lower Russian supplies.

Longer term, the affair is concerning because it is part of a renewed politicization of resource development—for an industry already struggling with the NIMBY (not-in-my-backyard) problem as well as ESG restrictions on fossil fuel investment. This is hardly new: the biggest development in the 1970s oil industry was not the rise to power of OPEC, but the shift by many resource producers, including non-OPEC oil producers, towards resource nationalism. Countries became less interested in attracting foreign investment of their petroleum, in part for ideological reasons, but also because higher prices meant their revenues had soared. Contrast that with the 1960s, when countries like Iran and Iraq pushed foreign operators to invest in more production capacity in order to receive more revenue.

The 1990s saw a reversal of this political regime, with the 1986 oil price collapse—widely predicted to be impossible—and failure of prices to recover—as many predicted was inevitable—left the industry decision-makers more focused on economics and returns. This was also true of many in government energy ministries, who increasingly had professional rather than political backgrounds. As a result, even though surplus capacity in OPEC was all but non-existent, the oil price remained low and stable, as the figure below shows. And yes, I know ‘stability’ is subjective but compared to the 1970s or 2000s, that was stable. (The price volatility is exaggerated by the scale of the graph.)

But then things changed. For one thing, the 1998 oil price collapse brought Hugo Chavez to power and he established a more aggressive pricing policy in OPEC. More importantly, he pushed most of the management and technical personnel out of the state oil company, replacing them with political allies and military officers. Production began a long slide downwards. At almost the same time, the U.S. overthrew Saddam Hussein, taking more oil of the market. Then came hurricane Katrina, the Arab Spring, and yadda yadda yadda as the economists say, the oil price soared. As in the 1970s, more left-leaning politicians and high oil revenues have increased resource nationalism in many places.

Exxon will presumably pursue a legal case against the Russian expropriation of its assets, as it did a decade ago against Venezuela. It won that ruling but is still trying to collect the damages. A legal victory against Russia might strengthen protection of foreign-owned assets more generally and make such investments more attractive: lower risks means lower borrowing costs. That would improve global oil supply in the long run.

The contrary case, where a post-war Putin attracts new investors who ignore his previous behavior, would strengthen the hand of state-run oil companies, such as from China, who are less concerned about political risk (rightly or wrongly) than private investors. This could also encourage greater resource nationalism in other countries, reducing investment and future oil supply, as in the 1970s, especially if sanctions against Iran, Russia and Venezuela put continuing upwards pressure on oil prices. It could also increase control of global oil supply by national oil companies, which could prove an ill wind for markets, especially in a new oil crisis.

One can hope that Exxon wins the battle against Russian expropriation of its assets, because it could prove to be a significant salvo in the ongoing war over resource nationalism and the losers would be not just the privately-owned oil industry but oil importers and consumers.