THE MAGAZINE

Russia's Oil Bust

By John Barham

Russia emerged as a big player in world oil markets a decade ago, but now it’s struggling to maintain production. Trouble in Russia’s vast oil patch could have impacts far beyond the oilfields of Siberia. An oil boom powered Russia’s post-Soviet economic renaissance, and oil is fueling President Vladimir Putin’s ambition to reclaim the Kremlin’s influential role on the world stage.

Russia is the second-largest oil exporter. It has the world’s eighth-largest oil reserves, with 60 billion barrels in proven reserves. It met almost half the rise in global oil demand over the past five years alone.  But many Russia-watchers doubt it can raise output much beyond current levels of 9.9 million barrels per day (bpd).

This wouldn’t just hurt Russia’s oil industry. It could hamper the Kremlin’s foreign policy in years ahead.

This scenario suggests that Moscow’s “idea of using oil as a geopolitical weapon is not very realistic,” says Bobo Lo, head of the Russia and Eurasia Program at the U.K.’s Royal Institute of International Affairs. Lo points out that the government gets more than half its budget revenues from the oil and gas industry.

Although forecasters think world oil demand could rise 2.5 percent in 2008, they expect prices to weaken over the medium term. Consensus oil market forecasts point to prices of $55 per barrel by 2011, about one-third less than today. This would impact Russia as revenues fell while companies would have to spend more just to keep their output stable.

Russian oil companies are not investing enough to keep raising output. Taxes are high, and aggressive oil-recovery methods may have damaged existing wells.

Growing government influence in the industry has not helped. President Vladimir Putin has brought Russia’s formerly independent oil industry under direct or indirect control of the Kremlin.  The oil tycoons linked to the government are trying to rake in profits as fast as possible, since they aren’t certain who will succeed Putin as president next year.

The Paris-based International Energy Agency, an advisory body set up by western governments, projected in a recent report that “Russian oil production could level off during the 2010 to 2012 [timeframe], potentially stalling growth until mid-decade.”

The Council on Foreign Relations says, “The current slowdown in the growth of Russian oil and gas output runs the risk of becoming a long-term trend.”

Dmitri Loukashov, oil analyst at Alfa Bank, goes further, saying “stagnation is unavoidable.” He paints “a very disappointing picture of fast deter-

iorating operational performance. We believe that these trends are already underway, as production from Russia’s onshore fields has been declining since February of 2007.”

Rapid production growth at the gigantic ExxonMobil-led Sakhalin-1 project has masked this trend, says Loukashov. This $17 billion venture on Sakhalin Island in the Russian Far East is building toward peak production of 250,000 bpd, with Asia as its main market.

Says Loukashov: “The operational difficulties of Russian oil fields caused by a decade of underinvestment are gathering steam and will only grow in the next several years, forcing oil companies to invest more and more to merely preserve the current level of oil production.”

Companies increased drilling activity by one-third since early 2007 and are investing $20 billion, but this has only been enough to keep output stable.

Putin could help by cutting taxes, but he has few incentives for doing so. In any case, Russia’s oil industry faces structural problems that are unlikely to be remedied by quick fixes. The dismantlement of privately owned Yukos Oil Company in 2006 upset foreign investors and recent actions against BP, Chevron, and Royal Dutch/ Shell have further dented international confidence. Moscow accused them of regulatory infringements.

Still, the lure of profits is irresistible; whatever the risks, foreign investors want to continue doing business in Russia. France’s Total signed a deal with state-owned gas producer Gazprom to take a 25 percent share in the Arctic Shtokman gas field in a 25-year deal. Putin and French President Nicolas Sarkozy brokered the $20 billion to $30 billion project. Clearly, western companies are confident they can manage the risks of investing in Russia. 

But as Venezuela’s President Hugo Chávez recently demonstrated when he nationalized oil holdings in the Orinoco Belt, companies operating in countries with weak property rights and legal systems have little recourse when the authorities decide to change the rules.

The RIIA’s Lo does not expect immediate difficulties, but long term, he questions Russia’s prospects. “Russia thinks it will be a pole in a multipolar world with the European Union and China and the U.S. I think it will be a second-rate power,” he says, adding: “It doesn’t have to be that way, but Russia should be careful.”

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