When one thinks of the Russian Federation, several things come to mind: vodka, long winters, and oil. While the signature drink and climate of Russia will always be mainstays, after 2014 it appeared to many that Russian oil might no longer be a force in the world. However, despite efforts from the European Union (EU) and the United States (US) to subdue Russian energy after the 2014 Crimean Crisis through sanctions, the country’s energy sector continues to possess a strong presence on the international market. This is evidenced by its partnerships with nonwestern allies, notably China, Venezuela and India, as well as its expansion into technological improvements, such as liquified natural gas (LGN), in its oil refining processes.

 

Crimea is a peninsula which Russia annexed from Ukraine in March of 2014, prompting the “Crimean Crisis,” which took place after the highly contested 2014 Ukrainian Presidential election. In the midst of the chaos taking place in Kiev in its aftermath, armed pro-Russian troops stormed the Crimean parliament building and declared Crimea an independent nation. These troops called for a referendum which declared that the people of Crimea wished to be part of the Russian Federation. The international community responded negatively to the results as illegitimate. Despite the backlash, Russia annexed Crimea, prompting international response through sanctions.

 

After the sanctions levied against Russian oil and natural gas firms Lukoil, Gazprom, Rosneft and Novatek went into effect, the Russian economy was rocked to its core. Although Putin reformed much of the economy in the early 2000s, Russia was still very much dependent on oil, and sanctions from two of the biggest oil consumers in the world proved a significant detriment. However, Russia has bounced back from these sanctions by fostering economic relationships with non-western allies.

 

Venezuela emerged as a key international investment opportunity for Russia. Venezuela is a country rich with oil reserves. However, it is currently experiencing an economic crisis and is also at odds with the United States, after a recent presidential election in which incumbent Nicolas Maduro was declared the victor. To stimulate its oil production, Russia has agreed to invest $5 billion in the petroleum industry. State oil company Rosneft has also agreed to lend $1.5 billion in cash to Venezuela, with Venezuela utilizing its stake in the energy company Citgo as collateral.

 

Russia is also forging closer energy ties with another emerging superpower in the world, The People’s Republic of China. Reuters reported that Rosneft signed an agreement with the state controlled ChemChina to supply up to 2.4 million tons of oil to the chemical company over the course of the one-year deal. Such a short deal signifies it could be a test to determine if the two nations have the potential to establish a strong relationship in the energy sector.

 

This partnership with China is important to Russia because China, like Russia, is classified as an emerging economy. Even more so China is currently engaged in a trade war with the United States and is actively looking for new trade partners, like Russia, in order to mitigate economic damage. This is significant because it appears that just as the U.S. created rift with Russia through sanctions, the trade war is now doing the same with China. Russia and China are now united due to alienation by the United States and will continue to foster a stronger alliance.

To the south, India has started importing large amounts of Russian LNG. A twenty-year deal between Indian state-owned GAIL and Gazprom for up to 2.5 million tons of LNG a year. This deal is significant since it is the first long term energy deal between the two nations. India has also invested in Russian oil with Indian firm ONGC Videsh developing a petroleum gas plant in Russia’s Tomsk region. The new energy deals are a part of an effort on both countries part to increase trade activity between the two nations, further demonstrated by the recent Indian purchase of a new air defense system from Russia.

 

Much like China and Russia, India is an emerging economy. Russia can reap huge benefits from investing in India’s energy sector. As nations in North America and Europe continue to be hostile to Russia, one can expect Russia to seek out stronger alliances with its Southeastern neighbors, as demonstrated by its energy deals with China and India.

 

Beside the multitude of bilateral trade agreements and foreign investment, Russia appears also to be exerting influence on OPEC. Russia is currently spearheading the “+” group of the new OPEC+. This new group is the original OPEC plus non-OPEC members such as Russia, Mexico, Azerbaijan and Kazakhstan.

 

The creation of the OPEC+ group provided Russia with greater power to influence how oil prices are formed. Recently as reported by CNBC, Russia and OPEC agreed to cut oil production by 1.2 million barrels per day (bpd). The Russian Federation, however, has been slow to implement the cuts, exporting a record 11.4 million bpd in December, while Saudi Arabia cut their output by 450,000 bpd.

 

Even if Russia does begin to adhere to the production cuts, Moscow only promised to reduce production by a maximum of 60,000 bpd, while the Saudis agreed to cut production by 900,000 bpd. This proves that Russia, a nation not a member of OPEC, is exerting a large amount of influence over the organization. With OPEC taking the brunt of the agreed oil production cuts and Russia stating they would like to keep the relationship temporary. Russia is coming out on top, benefitting from increased oil prices due to OPEC production cuts, while only having to sacrifice a small amount of its own production.

 

Meanwhile, Russia has also been investing in its own domestic technologies. Recently President Putin announced the creation of Russia’s first liquified natural gas floating storage container. This opens up the potential for Russia to start exporting natural gas through tankers. The development of the storage container is significant because natural gas is typically transported by pipelines. However, the new container allows greater freedom in the transportation of natural gas in its liquid form, allowing Russia to ship the commodity almost anywhere by sea.

 

This development has captured the attention of Japan’s Saibu Gas, who has expressed interest in a joint partnership with Russian natural gas producer Novatek. This joint partnership would expand the market for Russian natural gas to most of Southeast Asia, furthering expanding the dominance of Russian energy in the area.

 

Russia will continue to foster relationships with countries at odds with the United States as they have proven successful in their quest to remain a dominant force on the international energy market. Whether or not Russia will continue to exert influence over OPEC remains to be seen. If Russia is able to gain energy dominance at the expense of Saudi Arabia, one can expect conflict between the two nations. Despite efforts from the United States and the European Union to suppress the presence of Russian energy, Russia remains a major player on the international stage and will continue to increase their presence in the future.

Since late 2014, the United States domestic energy market has been in the midst of the worst industry downturn in nearly half a century. But investors are lying in wait, looking for the opportunity to jump back in. Optimal timing remains the only factor holding back reinvestment.

With crude oil’s recent price hovering around $50 per barrel, the probability of reaching sustained equilibrium at these prices is low, and the probability of continued decline is even lower. While overall energy market fundamentals continue to raise eyebrows, an investigation of the likelihood of improvement is increasingly necessary. Recent market flux and mergers and acquisitions activity signal a possible revitalization of the stagnant domestic oil and gas industry. Upstream companies, those that search for and extract oil and gas products, are currently attempting to both trim fat to improve their balance sheets and acquire new holdings to position themselves for rapid growth upon further price recovery.

These deals offer insight into possible positive attitude clues from the executive teams behind them. With companies willing to take on extra debt or raise funding through secondary equity offerings, mergers and acquisitions in this area should be taken as a strong bullish sign for investors. In particular, mergers and buyout attempts among smaller midstream companies increased precipitously over the last several months, which hints at the concerted industry effort to consolidate and improve operations efficiency.

However, the largest deals brokered over the summer season are perhaps the most indicative of positive industry sentiment. Recent deal activity by the larger upstream firms has focused on attempts to acquire new oil and gas plays ripe to be highly profitable when the supply glut ends.

Range Resources’ $4.4 billion acquisition of Memorial Resource Development exemplifies just this style of thinking. Memorial Resource Development held promising natural gas reserves in Northern Louisiana, making the company’s buyout essentially an investment in future production for Range Resources.

“The merger [would provide] core acreage positions in the two highest return, lowest cost natural gas plays … [and] complementary assets positioned near expanding natural gas and NGL demand centers.” Drew Cozby, former CFO of Memorial Resource Development explained the rationale behind the buyout given current market conditions to the Dartmouth Business Journal.

EOG Resources’ $2.5 billion merger with Yates Petroleum Company falls along the same lines. EOG Chief Executive Bill Thomas described the addition of Yates’ proven crude positions in Texas’ Delaware Basin and the Powder River Basin of Wyoming and Montana as “paving the way for years of high-return drilling and production growth.” With crude prices still below the breakeven $61 for the Permian Basin estimated by Labyrinth Consulting Services Inc., the deal’s creation of a 574,000-acre position in the heart of the region appears to be either a questionable gamble for the foreseeable future or a bold positioning strategy at the heart of Texas’s most profitable drilling region.

Expected to close by the end of 2016, Anadarko Petroleum’s $2 billion purchase of deep-water drilling access via Freeport McMoRan is also worth noting. Larger energy and exploration companies, such as Anadarko, continue to feel the weight of high proportional debt (38 percent Debt-over-Enterprise Value ratio relative to industry comparable numbers that hover around 28 percent, according to Yahoo! Finance) from low oil prices and are focused on generating the cash flow they need to fund deals that provide access to yet more profitable plays. The Oil and Gas Financial Journal estimates that $3 billion in free cash flow coming over the next 5 years from additional Gulf of Mexico reserves will allow them to do just this, with greater targeted investment onshore in the promising Delaware and Denver Basins.

What is the net result of the previous three deals? According to PLS Inc., merger activity within the industry was the highest in July 2016 at $8.4 billion since the pre-price-crash era, when the highest tally was $12.9 billion in July 2014. Aside from being seismic boosts in production deal flows that the industry has lacked for the last two years, these deals combined are the largest upticks in activity, as big upstream companies vie for exposure to the most profitable onshore regions of US natural gas and crude.

The frenzy among the nation’s largest public energy companies to complete deals in the Texas Permian Basin region has left private equity investment in their wake, according to Mergermarket. The competition for exposure has led to multibillion-dollar entry fees to the region — yet the failure of private equity firms to win deals thus far means that an excess of funds remains for investment around the Permian Basin and elsewhere domestically. Thus, while investments in choice reserves have already raised prices beyond suitable levels for all but the largest buyers, a strong bullish sign for the market remains in the large amount of capital pending deployment.

In terms of market momentum, the laymen investor looking to ride on the coattails of those first to act can only hope the deal frenzy delivers tangibly better equity valuations or higher crude prices. The willingness to spend billions on buying out firms certainly exudes confidence, but this is a market driven overwhelmingly by supply and not demand. With the energy industry’s ability to continually dodge the bullet of demand destruction from the time-consuming and costly nature of finding suitable alternatives, consumers will not need less oil any time soon. Thus, oversupply will continue to be the dominant variable in oil price fluctuations for the near future.

In this vein, broader geopolitics continues to signal that the opportunity for investment is still on the horizon. While positive signals came from the Organization of Petroleum Exporting Countries (OPEC) talks at Algiers, prices may witness the same malaise well into 2017 despite the initial optimism surrounding the output freeze agreement. As per OPEC, its tentative output cap for 2017 will set production levels lower by only 750,000 barrels per day from a previous 32.5 million barrels per day. Considering this number in the context of Russia’s 400,000 barrel per day increase in production for the month of September and the historic tendency for OPEC members to ignore individual quotas, the cutback will probably have relatively minor significance.

Yet, the OPEC decision to decrease output without accord from Russia is confusing. Based on each nation’s disagreements at the last OPEC meeting in April, Saudi Arabia and Iran should be the two states continuing to overproduce as each tries to win market share. In the same competition is Russia, who is now left to fill the void created by OPEC’s decreased production. Moreover, pressure from officials in Moscow will reinforce the predisposition of the country’s oil majors to pump more in order to spur economic growth after the freefall of the Russian GDP and the Ruble over the last two years.

While OPEC’s decision also eliminates geopolitical uncertainty from both Saudi Arabia and Iran through the next year, it preserves the United States’ role as the swing producer nation. Any increase in production by Russia will have to be met by decreased production from the United States, hence its role as the swing state. More specifically, Russia will use increased output as a weapon to force the United States to concede market share, which the domestic producers in the United States will do to protect prices.

From the OPEC arena, the increase in Russian production would have been anticipated, especially given Russia’s attendance at the OPEC talks in Algiers. Thus, much like the Saudi decision to flood the market with excess supply in 2014, Russian overproduction will keep American output subdued despite the promising developments in merger activity from domestic companies.

Should Russia continue to flood the market, as data from its third largest producer Rosneft OAO suggests it will, any gains created by OPEC cuts will be reversed. Worse yet, should Rosneft production levels reach a forecasted 20 percent increase for 2017, the market could be left with an even worse supply glut. As much as US producers would benefit from a return to normalized supply levels, many companies have short positions already prepared for its continuation.

When asked about the geopolitical climate’s effect on the balance sheets of US producers, Drew Cozby, former CFO of Memorial Resource Development, stated his company confronts these challenges by “actively hedging commodity exposure and attempting to lock in well economics … [to minimize] downside exposure.” Yet, confronting a market oversupplied by several millions barrels of excess production each day is nearly impossible.

Potential investors should also understand that these positions will, at best, only partially limit the full downside to Russia’s destructive overproduction, and that the market will probably remain oversupplied. Russia will hold the key to a price recovery in 2017 based on these terms, but the role is one they will not accept. Thus, the tide of domestic optimism and increased mergers and acquisition activity may remain overshadowed for the foreseeable future by these factors as they combine to stagnate the industry’s rebound.