The future of Russian energy

National Interest, The, Summer, 2005 by J. Robinson West

In the last four months, the Russians have been courting the Indians and Chinese, who are eager for access to reserves to fuel their surging demand. Both were rumored to have financed the Rosneft purchase of Yuganskneftegaz. The Chinese reportedly made a $6 billion loan for the long-term pre-purchase of oil. Tapping inexperienced international energy companies, even if cash-rich, to directly participate in developing Russian oil fields may not be the way to efficiently optimize Russia's huge resources. Neither Chinese nor Indian companies have sophisticated exploration experience, and they have no experience whatsoever in the Arctic or deep-water exploration.

Finally, Russia is also unique in the vast distance from its oil production, largely in western Siberia, to its borders and international markets, reached mostly via Black Sea ports. A huge web of pipelines is controlled by the state company, Transneft, which manages the movement of oil. Transneft has a powerful position, which it protects aggressively. Pipeline capacity is limited, creating constraints on the amount of oil that can be moved to export markets, so new production will be bottlenecked. In addition, Transneft is a state bureaucracy, with the attendant problems of accountability and efficiency.

International Implications

THE RISKS in Russia are large and could mushroom. The impact of the Yukos affair, combined with under-investment and the poor management of the Russian petroleum sector in general, is serious. PFC Energy estimates that Russian production, now 9.3 million BPD, will peak at just over ten million BPD in 2008. Without a huge infusion of capital, technology and management for further exploration and production, Russian production may hit a lower peak and begin declining sooner. Billions will also be needed to expand export capacity. Without a stable legal and operating environment, Russia will fail to meet its production targets. This in turn could damage the Russian economy and the prestige of the Putin Administration.

The world needs every barrel of Russian oil. With growing Chinese and Indian demand and the insatiable appetite of the United States, markets will be tight and even more reliant on the Middle East. Given today's high oil prices, Russian companies and the Russian government believe that they can fund a good part of new developments and even infrastructure projects themselves. Additionally, Chinese and Indian companies, with the strong backing of their governments, are ready to do business with Russian companies and the Russian government. Their investment criteria are more in line with the approach favored by their Russian hosts. Skills as well as money will be crucial, however, and they bring few. If as a result Russia cannot sustain its current oil production level, this will negatively impact world oil markets.

A faltering Russian oil sector would be a disaster for the world economy as well as for Russia itself. President Putin must recognize that he needs a petroleum sector with well-managed and well-capitalized oil, gas and pipelines. He is well within his rights to want the state to dominate it, but it must be managed efficiently. The Yukos affair, as well as infighting in the Kremlin and a lack of transparency and predictability, indicates that he is going in the opposite direction and could hurt Russia's interests as well as the world's if he does not correct his course.