Russian Energy Policy During President Putin's Tenure: Trends and Strategies (Business & Investment Review)

RUSSIAN ENERGY POLICY DURING PRESIDENT PUTIN’S TENURE: Trends and Strategies

Danila Bochkarev Series editor: Marat Terterov

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Publisher’s note Every possible effort has been made to ensure that the information contained in this publication is accurate at the time of going to press and neither the publishers nor any of the authors, editors, contributors or sponsors can accept responsibility for any errors or omissions, however caused. No responsibility for loss or damage occasioned to any person acting, or refraining from action, as a result of the material in this publication can be accepted by the editors, authors, the publisher or any of the contributors or sponsors. Users and readers of this publication may copy or download portions of the material herein for personal use, and may include portions of this material in internal reports and/or reports to customers, and on an occasional and infrequent basis individual articles from the material, provided that such articles (or portions of articles) are attributed to this publication by name, the individual contributor of the portion used and GMB Publishing Ltd. Users and readers of this publication shall not reproduce, distribute, display, sell, publish, broadcast, repurpose, or circulate the material to any third party, or create new collective works for resale or for redistribution to servers or lists, or reuse any copyrighted component of this work in other works, without the prior written permission of GMB Publishing Ltd. GMB Publishing Ltd. 120 Pentonville Road London N1 9JN United Kingdom www.globalmarketbriefings.com This edition first published 2006 by GMB Publishing Ltd. © Danila Bochkarev Hardcopy ISBN 1-846730-26-0

E-report ISBN 1-846730-27-9

British Library Cataloguing in Publication Data A CIP record for this book is available from the British Library

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Contents About the author

v

Introduction

1

1. The energy sector as a geopolitical lever

5

2. The new legal environment of the Russian energy sector

13

3. Russian production units

15

„ Oil reserves and production „ Gas reserves and production

4. Infrastructure strategy: main issues

27

„ Oil transportation issues z

Far East oil pipeline: a political case?

„ Gas transportation issues z

Energy dependence of foreign states on Russian gas exports

Conclusion

35

Notes and references

37

About the series: Russian foreign energy policy reports

39

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About the author Danila Bochkarev provides consultancy and research services in the area of Russian politics, Russian foreign and energy policy, European and international security issues and is generally interested in energy security and foreign policy/security issues. Prior to joining East-West Institute Global Security Program, Danila spent some time with European Parliament in Brussels and worked as a visiting research fellow at the Institute for European Studies, Université Catholique de Louvain (Belgium). In 2001, he was a trainee at the Foundation for Strategic Studies (FRS) in Paris. He holds an MA degree in Politics/Political Economy (University College London) and a DEA (MA) degree in History from University of Paris 1 (Sorbonne), a Candidate of Science degree in politics and a BA in International Relations (University of Nizhniy Novgorod in Russia). Danila Bochkarev has several academic distinctions, including being a Royal Dutch Shell and French Government (BGF) scholar, and received funding from the US Information Agency and European Commission. He is a native Russian speaker and fluent both in English and French. He can be contacted on [email protected].

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Introduction

T

he end of the Cold War and the collapse of the Soviet Union left Russia – formerly a independent state with 1000 years of imperial statehood tradition – in an ideological, identity and political vacuum. Fourteen years after the end of communism, the Russian elite are still occupied with the difficult task of shaping new national and foreign policy identities. Moscow decided to abandon two major Soviet foreign policy instruments (ideology and the ‘hard’ military power) and switch to other methods in order to increase Russia’s standing in the international arena and consolidate its influence within area of the Former Soviet Union (FSU). The US-dominated Revolution in Military Affairs (RMA), the crisis of the traditional United Nations (UN) system, the Kremlin’s financial difficulties, and proliferation of weapons of mass destruction (WMD) make Russia’s nuclear arsenal somewhat irrelevant in the present situation and, therefore, push Moscow to use other foreign policy tools it has available – such as that concerned with energy – in order to regain its status of a super power. Energy is currently Russia’s top economic and political priority and is considered to be the basis of the country’s non-military, ‘soft’ power in the 21st century. The main directions of Russian energy policy were drafted by the Presidential Administration in the context of managing Russian mineral resources and, in contrast to the Kremlin’s position towards the energy sector during the 1990s, have involved the establishment of much firmer levels of state control over energy resources. Russian President

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Vladimir Putin views cooperation in the energy field with major consumers as a primary means of elevating Russia to a position of global strategic significance. Putin, who sees himself more as CEO of a multinational corporation than president of a major power, has enacted a set of policies seeking to make Russia a world energy leader and therefore a strategic partner to the West. Furthermore, high international energy prices and rising Russian oil and gas production have assisted the Kremlin in using energy exports both as a foreign policy instrument in its relations with the key world powers, as well as a means of financing the modernization of the national economy. Russian energy policy is currently at an important watershed. On the one hand we are witnessing a substantial increase in the output of oil and gas and some analysts have spoken of Russia as a reliable, alternative source of energy to the international economy’s traditional dependence on oil & gas supplies from the Persian Gulf region. On the other hand, however, there are concerns that the current Russian energy strategy is drifting closer to the Venezuelan ‘energy state-capitalism’ model (Apertura Petrolera); where foreign energy companies are welcome to invest in the Russian energy industry, but only on Moscow’s conditions and in partnership with a state-controlled national energy company. Such strategies, in contrast to private sector-led exploitation of the Russian energy industry during the 1990s, have, for the most part, not been well received by investors, who more often than not prefer a more deregulated business climate. As will be discussed in detail

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in this report, Russian energy policy is becoming centered around four main pillars, all of which reflect the overwhelming importance of the energy sector to the Russian state: 1. The national energy sector is

rapidly becoming the Kremlin’s geopolitical lever and a source of ‘comparative advantage’ in global politics. 2. The new legal environment surrounding the sector and the Kremlin’s rigid control over the energy policy-making and decision-making processes. 3. A tendency towards more concerted state control over the country’s major energy assets and major energy companies such as Gazprom and Rosneft. 4. Government control over the export oil and gas export pipeline infrastructure. These pillars fit into a coherent, Kremlin-directed energy strategy developed under Putin’s first term in office.

The new Russian energy policy is based on Russia’s high standing in the international energy scene, and abundant oil and gas reserves – the estimates for Russian oil exports range from 150 million tonnes/year (pessimistic scenario) to 310 million tonnes/year (optimistic scenario). Russia will continue to be the biggest gas exporter in the world and gas exports will continue to grow. The strategy estimates Russian gas exports to be around 275–280 billion cubic metres (bcm)/year by 2020.1 Meantime leading energy consumers such as the United States, European Union (EU), China, India and Japan are competing for affordable and reliable sources of energy. They, moreover, intend to implement additional energy security measures and diversify their oil and gas imports. According to the International Energy Agency’s World Energy Outlook 2004, (WEO-2004) the world’s primary energy demand is projected to expand by almost 60 per cent between 2002 and 2030 with an annual rate of 1.7 per cent, despite a general

Table I.1. World primary energy demand (Mtoe) 1971

2002

2010

2020

2030

2002–2030*

Coal

1 407

2 389

2 763

3 193

3 601

1.5%

Oil

2 413

3 676

4 308

5 074

5 766

1.6%

bunkers

106

146

148

152

162

0.4%

Gas

892

2 190

2 703

3 451

4 130

2.3%

29

692

778

776

764

0.4%

Hydro

104

224

276

321

365

1.8%

Biomass and waste

687

1 119

1 264

1 428

1 605

1.3%

Of which traditional biomass

490

763

828

888

920

0.7%

4

55

101

162

256

5.7%

5 536

10 345

12 194

14 404

16 487

1.7%

Of which international marine

Nuclear

Other renewables Total * Average annual growth rate.

Source: World Energy Outlook 2004© OECD/IEA, 2004, p. 59.

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2 500 2 000

Mtoe

1 500 1 000 500 0 1971-2002 Coal

Oil

Gas

2002-2030 Nuclear

Hydro

Other

Figure I.1. Increase in world primary energy demand by fuel Source: World Energy Outlook 2004© OECD/IEA, 2004, Figure 2.1, p. 59.

increase in energy efficiency. Thus, ‘fossil fuels will continue to dominate global energy use and will account for some 85 per cent of the increase in world primary demand’.2 The Russian Energy Strategy to 2020 estimates that the demand for hydrocarbons will grow 2.5–4.0 per cent per year for the next 10 years.3 Demand for natural gas is expected to grow faster than for other fossil fuels. The bulk of this demand is expected to come from the power generation sector and is also explained by environmental concerns, low costs and operational flexibility, especially in connection with power generation combined cycle gas turbines (CCGTs). The growing importance of gas in the international energy market up-

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grades Russia’s profile as the leading natural gas exporter, but also enhances its position as a significant ‘oil player’: Russia’s accumulated oil and gas reserve base makes this country the world’s Number 1 in hydrocarbons. The geographical closeness to the major markets such as Europe, China and Japan together with enormous discovered and possible hydrocarbon reserves may help to attract necessary investment flows into the Russian upstream, midstream and downstream oil and gas sectors. International cooperation may be mutually profitable: energy consumers are looking for new alternative sources of oil and gas, while Russia is seeking new markets for its energy exports.

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1. The energy sector as a geopolitical lever

D

ifferent ‘energy dialogues’ can be used to ensure Moscow’s rapprochement with the West and Japan. In fact, good relations with the West can attract the foreign direct investment (FDI) necessary for President Putin’s plans of doubling Russia’s GDP. Furthermore, the issue of energy policy is of great importance, not only for the national energy complex but also for the future of Russian statehood. The oil and gas sector plays a major role in President Putin’s modernization strategy and exerts substantial influence on Russian foreign, economic and security policy. According to Dr Dmitri Trenin from the Carnegie Center, the Moscow policymaking process is controlled by siloviki, ‘the essential members of Putin’s regime. The role of economic reformers/big business… [is] confined to managing the economy’.4 Clifford Gaddy proposed a similar ‘state capitalism’ model for Russia and drew historical parallels: ‘…the creator of that German system, Walther Rathenau, faced exactly the same dilemma as Putin: How do you create a system that combines the maximum efficiency of private management with overall state control? …With the proper balance of persuasion and coercion, private owners have to be induced to do the right thing?’5 Moreover, the Russian political elite still considers realpolitik to be a major driving force in the system of international relations. In the context of the 21st century, ‘realpolitik is a combination

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of geoeconomics and geopolitics… governments’ ideological preferences as well as society’s values do not play a significant role’.6 In this context, President Putin: ‘has set three key foreign policy goals: economic modernization, achieving global competitiveness and reconstruction of Russia as a modern great power… Russia wants to rebuild itself as a great power on a regional scale based on a sound economy and backed by credible military might. Therefore, Putin does not seek control over Russia’s neighbours, but he wants the CIS leaders to take Russia’s interests into account’.7

Putin ‘wants Russia to be an economic tiger integrated into world economic systems and possessing strong ties with the EU being, at the same time, the dominant [and independent] regional power within the CIS’.8 The Kremlin, in particular, wants to use the role Russia plays in the security of energy supplies as a major foreign policy tool. Fiona Hill rightfully mentioned that Russia ‘transformed itself from a defunct military superpower into a new energy superpower’.9 Unsurprisingly, energy security will be the key topic of the July 2006 G8 Summit in St Petersburg. The Russian government also presents oil and gas infrastructure as the common point of importer and exporter perspectives for energy security and last, but not least, puts a

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special emphasis on the other major threats to the disruption of energy supplies, such as terrorism (‘terrorist premium’ on oil prices is believed to reach US$8 a barrel), depletion, political and social instability, etc. Moreover, possible instability also threatens the major maritime energy routes. As an example, the majority of Japan’s oil and liquefied natural gas (LNG) imports come from the Middle East, Australia and Indonesia; this geography of imports means that tankers have to pass through the potentially unstable South China Sea and the extremely vulnerable Malacca Straits (so-called ‘choke points’), which in itself creates a serious threat to major supply routes. Here again, Russia presents itself as a perfect partner from the point of view of supply source diversification. Moreover, the Far East’s ‘energy game’ creates the prospect for political reconciliation between Moscow and Tokyo; strengthened relations between Russia and Japan would be extremely important for the Russian economy and particularly for the Russian energy sector, which is looking for foreign investment. In return, the oil, LNG and pipeline gas coming from Russia may generate leverage on Middle Eastern oil-producing countries and give Tokyo small, but effective, bargaining power. The critical role of Russian gas exports to Europe – and potentially to the United States and Asia – as well as the increasingly important role of Russian oil exports to oil market stability, all raise the profile of Russia’s global importance in energy geopolitics. Therefore, energy issues have opened the door for bilateral cooperation with the world’s leading power, the United States. The interests of two former rivals partly coincide: the United States wants to diversify its energy supply and avoid dependence on oil coming from the turbulent and

6

unstable Persian Gulf, while Russia is looking for new potential markets for its oil and gas exports. Moscow also needs investment, ‘particularly in high-risk exploration or a technologically challenging development, such as offshore Sakhalin’.10 A second point of convergence is that Russia is becoming a premier energy producer, while the United States is the largest oil and gas consumer in the world, consuming 20 million barrels per day (b/d) and importing over 11 million b/d of oil. As such, the US oil ‘majors’ have both the means and the interest to pursue the energy expansion in Russia. In fact, energy multinationals generate more profits while extracting fuels. According to Forbes, ExxonMobil earned US$9.5 billion after tax in 2002 from extracting fuels.11 This is four times what it received from refining and chemical divisions. LNG is a third common point in US–Russian energy relations. Here, mutual benefits are obvious: Russian gas will reach the US market offering the highest gas prices in the world, while Washington will reach its strategic goal by diversifying US energy imports (eg the United States plans to boost the imports of more secure and easy accessible LNG to 180bcm by 2025) and ‘opening’ shorter and more secure maritime route to the US Atlantic coast. Unexpectedly, Hurricane Katrina and the war in Iraq gave new impetus to the ‘gas dialogue’ between Moscow and Washington. Fourthly, the US as an energy partner is crucial for Gazprom’s future US$20 billion Shtokman LNG project: not only will it bring necessary investment, but it will also help Russia’s entry to the US gas market. For example, the Russian Federation accounted for only 1.9 per cent of US oil imports in the first quarter of 2005; without enough cheap and easily extractable oil, Russian cannot

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become an important player on the US oil market. Natural gas, however, is a different story. The maritime route from the Barents Sea LNG terminal to the east coast of the United States is more than twice as short as than the traditional route from the Persian Gulf. Moreover, US gas prices are higher than in Asia and Europe. For example, European customers paid, on average, US$136 for 1000m3 in 2004 while, in the same period, US gas prices reached US$222.12 Despite the relatively high costs of LNG shipping, the difference in prices makes the ‘northern route’ profitable. Moreover, most experts expect a substantial decrease in the price of LNG shipment over the next ten years. Therefore the share of LNG, now at 30 per cent, is predicted to reach 50 per cent by 2030. Gazprom ‘is also considering building, by 2009, an LNG terminal and plant in Ust Luga, near St Petersburg, to liquefy gas shipped through the network of already existing pipelines’13 and to boost gas production and sales. Last, but not least, despite real divergences, energy security in East Asia may become a priority field for cooperation between Washington and Moscow. The biggest risk for energy security is East Asia’s dependence on Persian Gulf oil and the latter’s vulnerability to a supply interruption. To stabilize the situation, East Asia needs a new strategic petroleum reserve similar to those kept by the International Energy Agency (IEA) member states. According to energy expert David Goldwyn, ‘this new, self-financing reserve can stabilize global oil prices, cement a new US–Russian energy security partnership and encourage the Asia–Pacific region to diversify oil imports’.14 The proposed scheme is similar to the US Strategic Petroleum Reserve (SPR), entirely filled with US oil.

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Moreover, neither the United States nor Europe entirely depends on the oil supplies coming from the Middle East. In case of major supply interruptions, the IEA member state would be able to set up a ‘collective defence’ system to address the crisis, but this is not the case with Asia–Pacific countries: they neither have substantial energy reserves to ensure alternative supplies, nor do they have a regional energy security organization similar to the IEA. Moreover, in the case of a crisis, Asian countries ‘would be free riders on the IEA’s emergency response system, weakening the effectiveness of that response’.15 The US Energy Information Administration projects that the developing countries in Asia will account for 37 per cent of the total world energy demand growth by 2020. If these countries are not able to diversify their oil and gas supplies they will be extremely dependent on unstable Saudi Arabia and other Gulf countries for their economic survival. China has already collaborated with the ‘rogue states’, such as North Korea and Pakistan, providing them with nuclear and missile technologies. Stemming from this, Goldwyn claims that further cooperation between Beijing and Riyadh may lead to the support by both capitals of groups hostile to US, European and Russian interests. Unease regarding international energy security regime concerns may also improve the Kremlin’s relations with the European Union.16 Security of supply, one of Europe’s key ‘energy values’, is balanced by Russia’s need to secure energy markets, investment and new technologies. An energy conflict between Moscow and Kyiv in January 2006 stimulated discussion of a number of very important issues: a European energy policy, modification of the European energy mix (available options: more nuclear and renew-

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able), introduction of new energy saving practices, diversification of oil and gas supply (calls for more gas and oil pipelines and LNG terminals, unlocking the alternative hydrocarbon resources in Central Asia, etc.). Surprisingly, the conflict also gave additional impetus to the political dialogues with major energy producing/transit areas and may ‘push forward’ the EU-Russia Energy Dialogue. Therefore, energy security cooperation can create a trilateral (Washington, Brussels and Moscow) counterweight to OPEC influence and establish a viable energy dialogue between the United States, the EU and Russia. The projections of the Russian Energy Strategy to 2020 constitute the main ‘ideological foundation’ for the national development policy; its scenarios predict the production output and the Russian energy sector’s investment requirements. The Strategy also defines energy exports as a major instrument of Russian foreign policy

and a means for economic development in the short and mid-term. Thus, the main goals of the energy policy are to: „ export energy resources. „ transport energy (in most cases from Central Asia to Europe). „ attract FDI to the national energy sector. „ promote the exploration and production activities of the Russian fuel–energy sector abroad. „ increase the presence of Russian companies in foreign markets (both in upstream and downstream sectors). The Russian Energy Strategy to 2020 places special emphasis on Russia’s crucial role in the world energy mar kets, especially in relation to price management policy. More importantly, this strategy underlines the fundamental divergence between the ‘Western’ and ‘non-Western’ global-

Natural Gas Supply of the EU 2000 - 2020 in th million cm per Year 800 700 600

Add Imports from Russia, Caspian region Middle East, etc.

500 400 300

Planned Imports from Russia and North Africa

200

Imports from North Sea

100

Gas Production In the EU-25

0 2000

2005

2010

2015

2020

2025

2030

Supply must deliver 18,000 BCM in 30 Years of which 10,000 imported from Russia, North Africa, Middle-East and the Caspian, 2,500 imported from North Sea and 5,500 produced in the EU European Commission : DG TREN

Figure 1.1. Natural gas supply of the EU Source: Presentation of Mr. Cleutinx, Director, DG TREN at Eurogas/DG TREN conference ‘The European Single Market in the Global Dimension’, www.eurogas.org .

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ization and ‘mineral-wealth’ management models. For example, Professor Coby van der Linde argued that the Western model (‘strong globalization’) is aimed at removing ‘political barriers that limited access to raw materials, to oil and gas resources and to attractive new markets…[F]oreign direct investments are seen as the best tool to denationalize oil and gas’,17 while Russia, Iran, China and some other countries ‘formulated their own set of references for globalization’.18 They want to participate in ‘the international economy, but on the condition that the state’s long-term political, strategic, and economic national interests are served’19 – Shell Global Scenarios to 2025 present this dilemma as a conflict between the ‘Open Doors’ and ‘Flags’ scenarios.20 To summarize – the debate focuses on only one question: Who will control the oil-and-gas value chain? The new Russian Energy Strategy offers some answers. Rice University’s Baker Institute World Gas Trade Model (BIWGTM), a set of scenarios allowing for examination of the impact on the global markets of various economic and non-economic (geopolitical, social, etc.) factors came to the same conclusion. This model suggested that ‘Russia also eventually will enter the LNG trade in both [the] Atlantic and Pacific…providing additional links between gas prices in North America, Europe and Asia’.21 Russia is also expected to supply more than ‘50 per cent of total European gas demand post-2020’.22 Chris Weafer, chief strategist at Alfa Bank in Moscow and former advisor to OPEC in Vienna, underlined that Russia: ‘wants to be the new Saudi Arabia in terms of global energy – a global energy partner for consuming countries…the model that Russia is pushing is a more expensive version of that. Instead of just being a big global

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energy…Russia wants to be, and is able to be, a supplier of several types of energy… which gives it better political leverage’. 23

However, even a purely theoretical Russia-directed ‘gas cartel’ would not be able to assert monopoly power in world gas markets. Accessibility, the cost of oil and gas reserves, and the availability of spare capacity determine the ‘energy power’ of the country. Russia’s field for manoeuvre is seriously undermined by its incapacity to withstand low energy prices or a ‘price war’ war with Saudi Arabia (the dominant oil producer, disposing of 1.5–2 million barrels/day spare production capacity), or Qatar (possibly the only important gas producer able if necessary to immediately increase its gas production). Russia’s status as an ‘energy superpower’ is mainly based on the country’s huge oil and gas potential, very attractive to international ‘oil majors’ eager to renew their resource base (the oil majors’ production/resources ratio is on average equal to 12–14 years). Therefore, the assessment of Russia’s energy resource base, investment potential, the principle actors in this field, and energy infrastructure issues are crucial for a comprehensive understanding of Russian energy and foreign policy.24 Russia’s oil and gas reserve base is a source of major concern. In fact, difficult access to new hydrocarbon resources in Russia may undermine investor confidence and have negative repercussions on the general economic climate in the country. Contrary to the open date on the huge Russian gas potential, oil reserves (obviously, a weak link in the country’s energy balance) became a state secret on February 2004 – apparently in order to bring temporary uncertainty to the investment assessment of Russian oil potential. The decision

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35% 30% 25% 20% 15% 10% 5% 0% Canada

Norway

Russia

Algeria

Iran

Figure 1.2. Contributions of oil and gas sectors to GDP in selected countries (2002) Source: World Energy Outlook 2004© OECD/IEA, 2004, Figure 9.5, p. 289.

was based on the federal Law on State Secrets, adopted in November 2003. The volume and location of reserves, as well as information regarding the ‘amounts of extraction production and consumption of

Russia’s strategically valuable fossil fuels’ became confidential.25 However, Mr. A. Kudrin, Russia’s Minister of Finance speaking at Brookings in Washington on April 2006 made a sensational statement. The Kremlin is

Table 1.1. Russian Energy Strategy and World Energy Outlook 2004 projections to 2020 2002

2020 Energy strategy (high and low scenarios)

WEO-2004

619

794–881

802

Production (Mt)

383

450–520

531

Exports of crude and products (Mt)

248

305–350

351

584

680–730

801

*

169

275–280

249*

889

1 215–1 365

1 200

Energy sector Primary energy demand (Mtoe) Oil sector

Gas sector Production (bcm) Exports (bcm) Power sector Electricity generation (Twh) *

Net exports.

Sources: Government of the Russian Federation (2003); IEA databases (2002 data); World Energy Outlook 2004© OECD/IEA, 2004, Table 9.3, p. 292.

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ready to disclose the information on the national oil reserves. As Russia’s status of an ‘energy superpower’ is mainly based on the country’s huge oil and gas potential, it is therefore potentially attractive to international ‘oil majors’ that are eager to renew their resource base (their production/resources ratio is on average equal to 12–14 years). Therefore, this report particularly emphasizes the assessment of a Russian energy resource base, investment potential, principal actors in this field and oil/gas infrastructure issues. Russia also depends on the energy

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sector for its economic development. According to the estimates of the World Bank (2004), energy represents up to 25 per cent of the country’s GDP. Therefore, Russia’s dependence on the energy sector now approaches levels which are fairly average for OPEC countries. According to Edward Chow, an expert on international energy policy, Russia’s ‘export mythology’ may be similar to the Soviet myth that ‘the health of the country’s economy, national power and influence in the world are directly linked to the performance of its oil and gas industry’.26

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2. The new legal environment of the Russian energy sector

T

he Russian government is reshaping the energy sector by introducing new legal, and sometimes informal, ‘rules of the game’ to take control of major oil and gas assets. Institutionalization of the energy sector enabled the Kremlin to reassert the state’s control over major oil and gas assets – private energy companies should comply with the Russian government’s major foreign and domestic initiatives. The Yukos affair and the M&A deals of the Russian state energy companies Gazprom (Sibneft’s takeover in 2005) and Rosneft (former Yukos subsidiary Yuganskneftegas’ takeover in 2004) entirely fit the new ‘directed’ economic policy revealing one of the true goals of Russian energy strategy – to create powerful and state-controlled, vertically integrated energy companies that are competitive domestically and on the liberalized European, Asian, and possibly also US, energy markets. The swap of assets (25 per cent of Shell-led Sakhalin-II for a 50 per cent stake in the development of Neocome layers of Gazprom’s Zapolyarnoye gas field) fits in with Gazprom’s strategy of entering the Asian LNG and pipeline gas market. Moreover, the Russian gas giant has already entered the gas distribution business in Germany and Italy, two major consumers of Russian gas. Alfa Bank’s Matt Thomas and Anna Boutenko claim that ‘the company (Gazprom) is ideally positioned to “outsource” through [joint ventures] the man-

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agement of assets to project-starved foreign oil and gas companies’. Therefore, Alfa Bank experts expect Gazprom ‘to become a conduit for large-scale investment, spread through an array of [joint ventures]’.27 Indeed, this strategy will help the company to improve its financial performance and retain control of important gas projects. Rosneft is looks set to follow the same strategy. The Yukos affair was a clear defeat of ‘the rent-seeking model’ in the Russian energy sector: Yukos went against the new energy paradigm by excessively lobbying its own corporate interests and by trying to gain control over the legislative process – a distinct prerogative of the Russian presidency. The company also did not fit the profile of an ‘exemplary’ oil company, allegedly not paying its taxes and underinvesting in exploration and production activities. So, the new trend of the époque is that the management of the resource base is controlled by the state. For example, oil reserves (a ‘weak link’ in Russian energy balance) became a state secret in February 2004 – possibly to avoid an investment downgrade of Russia’s proven oil resources. The question of property rights is another pressing issue. The licence regime to be established under the new version of the Russian Subsoil Law challenges the traditional concept of mineral resources ownership; transferability of the assets and the right to access resources under the current licence scheme is limited.

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Moreover all oil fields with proven reserves of more than 150 million tonnes and gas fields with reserves of over a billion cubic metres are defined as ‘strategic’ and, therefore, the participation of the foreign investors in these projects is limited to 49 per cent. However, some exceptions would be possible for some existing projects, eg Shell-operated Sakhalin-II, and for development of giant offshore gas and oil fields on the Arctic Shelf. Alfa Bank’s chief strategist, Chris Weafer, underscored the point that a growing state presence might positively speed things up, both in terms of pipelines and auctions for new licences. ‘One of the reasons we are now seeing progress in long outstanding issues, such as the award of licences, is that the state now has the vehicles by which it…can take a dominant role in those licenses [itself]’.28

Foreign investors are also concerned with the future of production sharing agreements (PSAs) in Russia, the existence of which has been made almost impossible by the amended legislation. In the period from June to August 2003, the Russian Federation introduced certain changes to energy law and related legislation; for example, on 6 June 2003 President Putin approved the Bill on Supplementing Part II of the Tax Code of the Russian Federation, introducing

14

crucial changes in the Federal Law on Production Sharing Agreements (the PSA Law, dated 30 December 1995). These amendments ‘significantly curtailed the PSA regime by narrowing the range of grounds to be developed under such [a] regime’.29 Now the only opportunity to develop the subsoil plots would be the ‘lack of opportunity to explore and develop such plots under the general licensing regime, which lack should be confirmed by an unsuccessful action’.30 As such, these amendments make new PSA contracts practically impossible. A number of negative factors, such as an unstable investment climate, bureaucratic problems and imperfections in Russian legislation, create serious obstacles for foreign investors. As an example, Grant Aldonas, US Under Secretary of Commerce for International Trade, claimed that imperfections in Russian energy legislation are caus-ing ‘serious…hurdles to greenfield investment’31 which is considered to be the most attractive area for FDI in the Russian energy sector. He also warned that the Russian government’s energy policy promotes FDI only through M&A and predicted that what ‘we are likely to see is a movement towards consolidation… and acquisition rather than greenfield investment…and ultimately, reduced investment in the long term Russian energy industry’.32

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3. Russian production units Oil reserves and production

A

ccording to BP Review of World Energy – 2005, Russia remains one the world’s leading oil producers and exporters. The country produced oil totalling 9.285 million b/d in 2004 (or 11.9 per cent of the world’s total), which represented 8.9 per cent of the annual growth in production (11 per cent growth registered in 2003). Russia possesses 72.3 billion barrels of proven resources (6.1 per cent of the world’s total) with a production-to-reserves (P/R) ratio of 21.3 years. The P/R ratio may increase in the future, as will be discussed. In 2003, Oil and Gas Journal, a principal reference for BP’s energy statistics, estimated that Russian proven oil reserves totalled 60 billion

barrels. DeGolyer and MacNaughton, a leading auditor of Russia’s oil reserves, estimated ultimately recoverable reserves to be 150 billion barrels33 or 10–12 per cent of the total of the world’s undiscovered oil potential. Certain estimations go as high as 180 billion barrels,34 which theoretically ranks Russia second, after Saudi Arabia with its 261.8 billion barrels of proven reserves. Figure 3.2 shows the equal importance of enhancing oil recoveries and of still undiscovered resources in the future world oil production, which raises Russia’s profile as an important oil supplier of the 21st century. Traditionally, oil reserve standard classification systems are provided by the US Society of Petroleum Engineers (SPE) and the US Securities and Exchange Commission (SEC).

Km 0 400 800

St. Peterburg Moscow Kiev

Baku

Major pipeline Proposed pipeline Alternative routes for proposed Murmansk pipeline

Refinery Oil terminal Prospective region Producing region

Figure 3.1. Russian oil basins and pipelines Source: World Energy Outlook 2004© OECD/IEA, 2004, Figure 9.14, p. 302.

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125 100

mb/d

75 50 25 0 1971

1980

2000

1990

Existing capacities Enhanced oil recoveries Development of new discoveries

2010

2020

2030

Development of existing reserves Non-conventional oil

Figure 3.2. World oil production by source Source: World Energy Outlook 2004© OECD/IEA, 2004, Figure 3.20, p. 103.

Proved (1P)

Proved + Probable (2P)

Proved + Probable + Possible (3P)

CONTINGENT RESOURCES Low estimate

Best estimate

High estimate

Unrecoverable PROSPECTIVE RESOURCES Low estimate

Best estimate

High estimate

Increasing degree of geologic assurance and economic feasibility

Commercial Sub-commercial

Discovered petroleum initially in place

accountancy principles. Soviet, and later on Russian, classification was also primarily based on geological

PRODUCTION

Undiscovered petroleum initially in place

Total petroleum initially in place

The former takes into account only geological data, while the latter is also based on the strict financial

Unrecoverable

Figure 3.3. Hydrocarbon resource classification Source: World Energy Outlook 2004© OECD/IEA, 2004, Figure 3.7, p. 88.

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statistics. In 1997, the World Petroleum Congress adopted exact definitions for ‘proven’, ‘probable’ and ‘possible’ oil reserves: „ 1P: (‘Proven reserves’) with a 90 per cent probability of profitable drilling. „ 2P: (‘Proven plus probable’), with at least 50 per cent probability of profitable drilling. „ 3P: (‘Proven plus probable plus possible’) – probability of at least 10 per cent Subsequently, the classification process went further and even the UN Economic Commission for Europe aimed to develop the Framework Classi-fication for Energy and Mineral Resources.35 The SEC estimates are known as the most detailed and most conservative in the world. For example, only proven reserves with a probability of commercial drilling of over 90 per cent can be taken into account and later incorporated into companies’ financial documents. Therefore, the ‘stock exchange’ value of an oil company highly depends on SECcompatible statistics. To date, only two Russian oil companies (Lukoil and Yukos) published their statistics in accordance with the SEC criteria. In fact, application of different methods leads to different estimates of Russian oil reserves and production. According to Oxford Analytica, ‘the typical Russian development plan calls for a 34 per cent [of original oil in place (OOIP)] recovery from the major fields in Western Siberia’, while it is only 24 per cent according to SPE standards, and as little as 18 per cent according to the SEC criteria.36 It shows an enormous potential for an oil reserve upgrade if proper management and technological solutions are being introduced. As such, many companies are constantly updating

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their reserve information. Thus, Yukos (together with its former subsidiary Yuganskneftegaz) already possessed 1437 billion barrels under strict SEC standards by the end of 2003, while BP-TNK disposed of 9 billion barrels and expected to have 30 billion in the longer term. Oxford Analytica experts claimed that: ‘as Russian firms have very high reserve lives – from 20 to 35 years compared with an average of 12 years among the international majors – they are likely to boost production further, at rates of 7–15 per cent per annum’.38

However, production currently grows much faster than the proven oil reserves, which is a source of major concern for the Russian government. According to the IEA, Russian oil exports are ‘predicted to rise from 5.6 million b/d in 2003, to 7.3 million b/d in 2010, and to decline afterwards due to the sensible increase in domestic demand for energy’.39 It is estimated that the ‘average investment needed per barrel of capacity stands at around US$13,000, which is higher than in most other parts of the world’.40 However, these estimates differ: Adam Landes, Managing Director (Oil & Gas) at Renaissance Capital in Moscow, claimed that: ‘Russian oil has displayed some formidable competitive advantages through primarily two factors: their cost bar tax is much lower than anywhere else and…the reinvestment requirement to add another barrel has been formidably low’.41

However, the Yukos affair downgraded Russian oil sector investment potential. This trend may, in the long run, represent a serious obstacle for development of the Russian oil industry. Some technical problems still

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195 190 185 180 175 170 165 160

190 184,9 178,3 168,8

1999

2002

2001

2003

Figure 3.4. Russian Federation oil refining (MMT ) Source: Energy Charter Secretariat (Brussels, 2005), Russian Federation: Investment Climate and Market Structure in the Energy Sector (Moscow, 2004).

would also be crucial for the security of energy supplies.44 The introduction of new technologies and management practices has helped to raise productivity and output but many problems, mainly due to poor investment flows, still remain unsolved. For example, Lukoil’s CEO, Vagit Alekperov, in an interview with Izvestia, one of the leading Russian daily newspapers, said that ‘Russia’s natural resource base is in a dreadful state…with companies replacing only 85 per cent of [the] reserves [that] they produce’.45 Moreover, insufficient growth of the national refining capacity (actually

persist: despite the fact that average oil-well productivity ‘rebounded from 51b/d in 1996, to 66 b/d in mid-2003’ it is still lower than in other oilproducing regions.42 Total investment in Russia’s upstream oil industry was US$7.7 billion in 2003 – three times higher than it was in 1999. It finally reached US$11 billion in 2005, but is still insufficient to start new major greenfield projects.43 For example, both the Russian Energy Strategy, 2003 and the IEA estimated that US$14–16 billion investment per year would be necessary if energy companies want to develop new oil fields; investment

12 10

mb/d

8 6 4 2 0 1990

1995

2000

Net exports

2005

2010

2015

Consumption

2020

2025

2030

Production

Figure 3.5. Russian oil balance Source: World Energy Outlook 2004© OECD/IEA, 2004, Figure 9.13, p. 301.

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251.5 output (million tonnes)

year-on-year change (%)

146.5 40

29.5

30 23.3

8.1

20.6

20

16.6

7.8

7.5

11.3

10.0

3.3

11.0 8.4 7.6 6.8 6.0 3.9 1.9

10 3.2 -10 Total (inc. others)

Bashneft

Sidance

Slavneft

Tatneft

-64.4

Yukos

Sibneft

TNK

Surgutneftegaz

Rosneft

Lukoil

0 -3.2

Figure 3.6. Russian crude oil production (Jan–Apr 2005) Source: ‘RUSSIA: State-owned firms are set to dominate oil’, Oxford Analytica (June 22, 2005)

5.412 million b/d) represents a serious challenge for the development of the Russian oil industry (Figure 3.4). Different estimates of Russia’s upstream and downstream industry produced a vast range of opinions on the future of the country’s export potential. The Moscow-based Centre for Oil and Gas Business (Tsentr Neftegazovogo Biznesa) estimated that Russian oil exports outside of the CIS will increase from 4.2 million b/d in 2004, to 8.8 million b/d in 2012.46 The IEA remained more sceptical regarding the Russian oil boom (Figure 3.5). According to the IEA, despite recent growth in national oil output, the share of Russian exports in world trade will fall after 2010, ‘as Russian production stabilizes, domestic demand expands and output picks up in the Middle East’.47 Different oil data sources (Russia’s Energy Strategy 2003; OPEC; World Energy Outlook 2004) expect Russian oil production to grow from 8.5 million b/d in 2003, to 10.4 million b/d by 2010, and to peak at 10.8 million b/d in 2030. The Russian Ministry of Economic Development and Trade estimates that the national oil industry is experiencing significant difficulties; according to official statistics.

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‘…in 2004 oil production grew by 9 per cent and export by 13.1 per cent, then in 2005, production went up by only 2.3 per cent and export dropped by 1.2 per cent. In 2006, production is supposed to grow by 3 per cent and export by 4 per cent. In 2007, production is supposed to increase by 2.3 per cent and export by 3.8 per cent. And finally, in 2008, increase in production will be only 1 per cent and export only 1.8 per cent’.48

Discouraging news for private investors is that there is also a clear tendency for the state to increase its participation in the Russian oil industry. State-controlled oil companies (as of December 2005) produced 46.2 million tonnes or around 32 per cent of the country’s entire production in January–April 2005 (Figure 3.6). It is generally considered that the Kremlin would increase further state participation in the oil industry both for political and economic reasons; the 100 per cent state-owned oil company Rosneft is ‘the leader in terms of profit and tax paid per tonne of oil’.49 The Russian industrial sector cannot compete with fast-growing Indian and Chinese industrial production. Therefore, Russia’s GDP growth and

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Talakanskoye fields in Eastern Siberia.51 Despite the creation of the Government Stabilization Fund, which is predicted to increase to US$280 billion in 2009,52 the Russian economy remains very sensitive to international energy prices. According to Alfa Bank estimates, a US$1 per barrel drop in the price of oil may have cost Russia US$2 billion in export revenues and US$1 billion in budget revenues in 2004. It also may have, theoretically, caused a decline of about 0.4 per cent in Russian GDP per year. Table 3.2 shows that economic growth (the multiplier effect) remains dependent on oil prices; as an example, in 2003 the high oil prices accounted for 42 per cent of the annual GDP growth. Contrary to the myth about exorbitant oil taxes in Russia, the high oil prices also profit oil companies. According to Alfa Bank, ‘Russian oil producers, on average, get to keep

short-term economic development and prospects for economic diversification depend on high oil and gas prices. American energy expert Edward Chow critically underlined that ‘the luxury of higher oil prices has stalled the reform process in the Russian energy sector’.50 The oil companies’ experts were previously more optimistic; for example, TNK corporate analyst, Tatiana Magarshak, showed in a detailed presentation based on published plans of the country’s major oil companies and estimates provided by Russia’s Energy Strategy, that Russia’s oil production could reach more than 12 million b/d by 2012. This estimate included oil from fields which those companies already possess (regions primarily in Western Siberia), as well as 500,000 b/d of output from newly developed fields in the Timan-Pechora region and the Verkhnechonskoye and

Table 3.1. Estimate of Russian oil reserves (billion barrels) Source

Proven reserves

ABC1 reserves*

40-60

90

CERA (Cambridge, MA)

70

90-100

DeGolyer and MacNaughton

65

140

Oil and Gas Journal/BP Statistical Review of World Energy

60

n/a

Wood Mackenzie

75

116

Centre for Global Energy Studies (London)

*Proven plus probable oil reserves Source: Company data, Oxford Analytica, 18 May 2004

Table 3.2. 2000 (%)

2001 (%)

2002 (%)

2003 (%)

Reported GDP growth y-o-y

8.3

5.1

4.7

7.0

Oil price effect y-o-y

2.8

1.5

1.5

3.0

‘Base’ GDP growth*

4.5

3.6

3.2

4.0

*Based on US$20/bbl oil average Source: Russian State Statistics Committee, Alfa Bank estimates, 2004

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20 per cent of each US$1/bbl price increase above US$25/bbl’.53 However, Russian energy exports directly depend on international oil prices. According to the Russian Ministry of Fuel and Energy, oil and gas exports may decrease if oil prices fall below the ‘psychological barrier’ of US$13–15 per barrel. The country’s main business indicator, the Moscow Stock Exchange (RTS) Index, correlates with international oil price fluctuations. However, it is not only Russia’s economy that is based on energy; many neighbouring countries also depend on Russian oil imports, as shown in Table 3.6, Table 3.7 and Table 3.8. Figure 3.9 outlines Russia’s leading oil companies. All of them, with the exception of Yukos and Bashneft, keep increasing their oil output. This indicates a general trend in national oil production that is moderately positive. The conclusion is that foreign ‘oil majors’ will continue to invest in the Russian oil industry, although not on

the scale and in the manner previously expected. As an example, no other investment projects to date have surpassed the TNK-BP joint venture deal. In fact, the TNK-BP deal ‘marked the zenith of this optimism, but the balance swung against them’.54 Moreover, 50:50 joint ventures or majority participation of foreign capital is less probable. On 29 September 2005, US oil major ConocoPhillips bought 7.59 per cent of Russia’s Lukoil for US$1.98 billion and continued to steadily increase its share in this company (now estimated at 20 per cent). Although, ConocoPhillips is not expected to control more than 25 per cent of Lukoil, the deal was a sign of cautious, but at the same time positive, interest in Russian energy resources. Therefore, it seems that foreign oil companies are welcome to invest, but under terms set by the Kremlin – in other words, they should work in partnership with a state-controlled company and provide funds, technological ‘know-how’ and marketing expertise in exchange for an enlarged resource base and access

Table 3.3. Oil prices per barrel (US$)

2002 export of energy

2010 export of energy

2020 export of energy

18–20

1.0

1.23–1.25

1.25–1.3

up to 30

1.0

1.30–1.35

1.45–1.5

13–15

1.0

0.9

0.85

Source: The Ministry of Fuel and Energy, Russian Federation, 2004

Table 3.4. Alfa Bank revised oil price forecasts (US$/bbl) Forecast Old forecast New forecast

2005

2006

2007

2008

2009

Brent

33

28

25

25

25

Urals

30

26

23

23

23

Brent

44

37

33

29

26

Urals

40

34

30

26

23

Source: Alfa Bank research, 2005

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2003

2004

2005f*

2.0

2006f*

1.8 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2

Lukoil

0 Rosneft TNK-BP Surgut- Sibneft Slavneft Tatneft Yukos Bashneft Others neftegaz *consensus forecast (Alfa Bank, Aton, Brunswick UBS, Renaissance Capital Trust United Financial Group)

Figure 3.9. Russia: oil output by company (million b/d) Source: ‘RUSSIA: State-owned firms are set to dominate oil’, Oxford Analytica (June 22, 2005)

Table 3.5. Russian ‘oil majors’ Company

Lukoil

Oil export via Oil produced in Market Capital- Oil refined in Russia, Jan–Oct 2005 Russia, Jan–Oct 2005 Transneft pipeline sysization (US$ tem, Jan–Oct 2005 (million tonnes) (million tonnes) billion) (million tonnes) 45

31.9

73

28.3

Rosneft

¤26.4

8.6

61.5

28

TNK-BP

¤22.6

14.9

72.4

30.7

(together with Slavneft) Surgutneftegaz

38.1

17.3

53

22.4

Sibneft

17.1

15.2

37.6

12.9

Tatneft

6.9

6

21.2

10.8

Yukos

2.5

28.9

20.8

1.4

2

6.4

9.9

3.5

Bashneft

Source: Kommersant Business Guide Oil and Gas, 14 December 2005; CDU TEK, Energy Ministry’s central dispatch unit CDU TEK; Energy Ministry’s central dispatch unit, (¤) Estimates: Rosneft and TNK-BP are not traded on the Moscow Stock Exchange (RTS). Rosneft’s capitalization is expected to reach US$50 billion after the launch of a formal IPO.

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to the new oil reservoirs, which represents a clear advantage for publicly traded companies. For example, Lukoil possesses 1.5 per cent of the world’s oil reserves (second in the world among privately-owned companies after ExxonMobil) and produces 2 per cent of the world’s oil (sixth place according to the same classification), which made this deal extremely valuable for ConocoPhillips (eighth

in the world terms of reserves and production).

Gas reserves and production Russia is widely known to have the world’s largest gas reserves and gas is also considered to be the country’s main economic and foreign policy instrument, especially in the context of

Table 3.6.Country with high dependence on Russian oil imports Country

Oil deliveries from Russia Share of Russian oil in Share of Russian oil in total (million tonnes) total consumption (%) imports (%)

Latvia

1.866

100.0

100.0

Lithuania

8.661

100.0

100.0

Slovakia

5.551

98.8

99.2

Poland

17.181

98.3

99.4

Ukraine

19.091

90.6

100.0

Hungary

5.273

79.7

100.0

Finland

7.692

69.9

70.4

Czech Republic

4.452

67.7

69.4

Slovakia

5.8

85.6

79.5

Bulgaria

2.411

46.1

46.2

Croatia

2.116

43.8

54.3

14.5

40.0

40.0

Switzerland

Table 3.7. Countries with average dependence on Russian oil imports Country

Oil deliveries from Russia Share of Russian oil in Share of Russian oil in (million tonnes) total consumption (%) total imports (%)

Romania

3.997

29.8

62.8

Germany

26.395

24.2

24.8

2.149

24.1

29.3

Italy

20.907

23.5

24.9

The Netherlands

10.864

21.5

22.4

Sweden

4.030

19.5

19.5

Turkey

3.627

13.6

15.1

Austria

Source: Kommersant Business Guide Oil and Gas, 14 December 2005; BP Statistical Review of World Energy 2005; IEA Oil Information 2004; IEA Energy Statistics of non-OECD countries 2002–2003; 2003 data, some small divergences are possible due to the fact that some Russian oil traders are registered offshore

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56.7 6.6

7.5

71.6 13.8

12.3

7.3

4

World total: 180 tcm as of 1 January 2004

Figure 3.10. World proven reserves of natural gas Source: World Energy Outlook 2004© OECD/IEA, 2004, Figure 4.4, p. 137.

the recent ‘gas war’ between Russia and Ukraine. Valery Nesterov, an oil and gas analyst at Russian investment bank, Troika Dialog, predicted that ‘while the 20th century was the century of oil, the 21st century will be the century of gas’.55 According to Cedigaz, the widelyquoted primary source of global gas reserves data, on 1 January 2004 Russian proven reserves of natural gas amounted to 56.7 trillion cubic metres (tcm), as shown in Figure 3.10. BP’s estimates are lower: 48 tcm (26.7

per cent of the world’s total). The country enjoys a high reserve-toproduction (R/P) ratio (81.5 years), but most of the new untapped fields are situated in harsh climatic zones, very often offshore in the Arctic. Russia is producing about 25 per cent of the world’s gas and continues to be a key world gas player with 148.44bcm of natural gas exported outside the FSU in 2004. Russia’s role is becoming even more important if we take into account the current tendency to increase gas prices for

Table 3.8. Countries with low dependence on Russian oil imports Country

Oil deliveries from Russia (million tonnes)

Share of Russian oil in total consumption (%)

Share of Russian oil in total imports (%)

Greece

1.387

7.0

7.0

France

5.531

6.4

6.5

Spain

3.145

5.5

5.5

Great Britain

3.330

4.3

23.8

China

7.365

3.2

10.6

United States

7.886

1.0

1.5

Japan

1.442

0.7

0.7

Source: Kommersant Business Guide Oil and Gas, 14 December 2005; BP Statistical Review of World Energy 2005; IEA Oil Information 2004; IEA Energy Statistics of non-OECD countries 2002–2003; 2003 data, some small divergences are possible due to the fact that some Russian oil traders are registered offshore

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gas producers are predicted to double their production by 2020, and to reach the threshold of 140bcm.

consumers inside the CIS. Russian gas production grew to 589.1bcm, which represents over 21.9 per cent of the world total.56 There has been a substantial slowdown in production growth (1.8 per cent in 2004, but 4.2 per cent in 2003) due to poor exploration activities and a failure to apply energy-saving technologies. Vladimir Livinenko, rector of the Mining Institute in St. Petersburg, argued that about 30 per cent of the total volume of energy produced in Russia is simply lost due to the ineffective structure of the energy mix and irrational use of the natural gas.57 Gas is also the main fuel in Russian energy production. It is believed that ‘in 2002, gas production [in] Russia accounted for 45 per cent of [the] main fuels and energy resources converted to fuel equivalent’.58 The Russian gas market is almost entirely dominated by the statecontrolled energy company, Gazprom, active both in the gas and oil businesses. However, independent

Gazprom Gazprom is the key Russian gas producer: in 2004, it produced 542.8bcm of natural gas. The company owns around two-thirds of Russian gas potential and produces 90 per cent of gas. Gazprom enjoys a monopoly right to export gas abroad (the company exports one-third of its production) and owns all gas transportation pipelines in Russia. It also produces gas together with its foreign partners: in Sakhalin with Shell (Sakhalin-II), in Urengoy with Wintershall (Achimgaz), and plans to expand further (in East Siberia’s Kovykhta together with BP and in Shtokman with several foreign oil majors). The Energy Charter Secretariat estimates that in order ‘to be able to export and ship such large volumes of gas, Gazprom established a broad network of joint

RUSSIAN GAS SOCIETY

Gas Production in Russia (billion cm) 800 665

700 600

595.1

619.8 633.2

71.3 79.6 90.4

110

730

Total

140

Independent gas companies GAZPROM

555

590

542.8

300

540.2

400

523.8

500

2010

2020

200 100 0

2002 2003 2004

Slide 6

Figure 3.11. Gas production in Russia (bcm) Source: Presentation of Mr. E. Zayashnikov, Member of the State Duma at Eurogas/DG TREN conference ‘The European Single Market in the Global Dimension’, www.eurogas.org .

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ventures, covering its numerous trading partner countries’, probably to diversify its export strategies: the deliveries of Russian gas to the Asia-Pacific region may reach 15 per cent of total exports by 2020.59 Gazprom is also the leading exporter to the European gas markets and the biggest gas exporter in the world. In 2005, the company exported 145bcm of natural gas outside the FSU. The share of Gazprom’s gas on the European markets reached 40 per cent of all imports and 26 per cent of the total consumption.

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The Russian government has recently gained control over the company by acquiring a 10.4 per cent stake. In September 2005, Gazprom’s management team followed the Kremlin-directed energy policy and bought 72.7 per cent of the private oil company, Sibneft, for US$13 billion. Afterwards, in December, President Putin signed a bill removing the restriction on foreign ownership of Gazprom shares. Consequently, the capitalization of the company reached US$151 billion in December 2005,60 and is expected to approach US$300 billion by the end of 2006.

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4. Infrastructure strategy: main issues Oil transportation issues

T

ransportation and infrastructure issues are playing a substantial role in Russian energy policy. Taking into account the importance of energy exports for Russia, the Kremlin put the diversification of export routes as one of the top energy priorities (Russian Energy Strategy to 2020, published in 2003). Thus, export diversification is presented as a matter of national security and is realized in the new ‘independent’ export routes (eg North European gas pipeline), avoiding transit countries. The discussion on the pipelines or LNG export destinations helps the Russian government to use oil and gas as a geopolitical/geoeconomic lever and balance between the United States, the EU, Japan and China. The transportation of hydrocarbons is based on a special federal law On Major Pipeline Transmission (currently under revision), which regulates the use of pipeline infrastructure, transportation tariffs and investment procedures. Formally, the Russian Federal Energy Commission (FEC) is responsible for establishing transmission tariffs and delivering export quotas for private oil companies (see www.transneft.ru); the opaque administrative procedures of the FEC, however, prompted many rumours on widespread corruption practices in this institution. The majority of Russian oil is exported by the state-controlled pipeline monopoly, Transneft (75 per cent of shares and 100 per cent of voting

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rights belong to the Russian government) and Transnefteprodukt (a Transneft subsidiary) transports petroleum products. Transneft actually develops four main sea directions for oil exports (Baltic Sea, Black Sea, Mediterranean and East Siberia) and tries to overcome the major transit obstacles for Russian energy exports. More than 53 per cent of oil exports delivered by Transneft in 2003 transited through third countries (mostly via the strategic pipeline system, Druzhba). Russia has a quite well-developed oil pipeline infrastructure consisting of 48,000km of crude oil pipelines and around 20,000km of petroleum pipelines,61 although the United States has three or four times as many oil pipelines for territory that is almost half the size. The underdevelopment of pipeline infrastructure slows down the growth in oil and gas production and prevents further FDI from coming into Russia’s upstream sector. Much like 30 years ago, Moscow is: ‘…desperately in need of new export facilities: large diameter pipelines and deepwater marine terminals to transport increasing volumes of oil to higher-value world markets in the large ocean-going tankers favoured in international trade’.62

The Russian government clearly understands the importance of constructing new pipelines to validate Moscow’s role as a world-leading energy exporter but, at the same time, continues to keep state control over the major gas and oil export routes.

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It is obvious that the Kremlin gives preference to state-owned or statecontrolled pipelines. The Russian government has never favoured the idea of privately owned strategic oil pipelines and implicitly informed the major Russian oil companies of this. Apparently, Russian oil companies got the message: when asked about private pipelines, the former CEO of Yukos, Simon Kukes, was extremely negative and praised the oil pipeline monopoly, Transneft. He commented: ‘we’ve got Transneft, who has one of the lowest tariffs in the world…they operate very nicely and keep increasing export capacity through drag-reducing agent and putting in new pumps’.63 Oil exports are constrained due to two major impediments: limited pipeline capacity and export quotas imposed by the Russian government to ensure relatively low-cost domestic supplies. Transportation bottlenecks alone represent a serious challenge for the Russian oil industry: over 33 per cent of oil is being transported by rail, which reflects the lack of sufficient pipeline capacity. Moreover, in the long term, rail deliveries may become unprofitable if oil prices fall. To overcome this problem, the Russian oil transportation company is

PIPELINE 60%: 4 million bbl/d

building new pipelines and increasing the capacities of those that already exist. It is engaged in: „ expanding the Baltic Pipeline System’s (BPS) pipeline capacity from 1 million b/d to 1.24 million b/d; „ developing a US$15 billion Far Eastern oil pipeline to Nakhodka deep-water oil terminal on Russia’s Pacific coast (total capacity 1.6 million b/d). A Japanese offer of US$7 billion for the project and the Kremlin’s fears of China’s demographic and economic expansion in the Russian Far East may downplay a less expensive alternative route to Chinese Daqing. This pipeline is also supposed to stimulate exploration and production activities in Eastern Siberia.

Far East oil pipeline: a political case? The choice of the destination for the Angarsk–Nakhodka export route is one of the controversial political issues linked with international oil supply. The Economist claimed that ‘Russia is unlikely to replace the Middle East as the West’s main source of oil, but

BARGE & OTHER 7%: 2 million bbl/d

RAIL 33%: 2.2 million bbl/d

Figure 4.1. Russia’s modes of oil transport (Jan–Sep 2004) Source: US Department of Energy, Energy Information Agency Country Analysis Brief, www.eia.doe.gov/emeu/cabs/russia.html

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when Russia eventually builds a Far East pipeline, it will forge closer ties with Asia’.64 Many international affairs experts also have serious doubts relating to the benefits for Tokyo arising from the construction of the Nakhodka pipeline. ‘the Kremlin’s preference for a pipeline to the Pacific, which will cost more than one to China, seems to be based on political motives. I am not sure this is in the long-term interest of Russia…when negotiations are based on mutual economic advantage they can strengthen relations in general. If they are influenced by political factors or worse (bribery), then they can prove to be political problems in the long run’.65 Jack Matlock, former US ambassador to the USSR

Energy expert claimed that:

Edward

Chow

‘a pipeline from Angarsk to Nakhodka would be roughly twice the distance of a pipeline from Angarsk to Daqing, cost twice as much to build…and require double the throughput guarantee and proven oil reserves to be supported… Since Japan has a huge economy concentrated on relatively small islands it already has an ideal diversity of supply: Japan can purchase oil from anyone in the world by tanker. If Japan assumes that Russian supplies from Nakhodka will somehow be lower-priced than competing supplies arriving by ship, it should rethink the numbers: a simple net present value calculation coupled with reasonable assumptions about demand growth in Japan indicates that US$5 billion of Japanese money spent today on a pipeline would add about US$2/barrel to every imported barrel… Japan could have afforded to pay a US$2/barrel premium for every barrel to give it a competitive edge

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against every other oil consumer on the market, and still come out even’.66

An unnamed senior Russian oil industry executive claimed that the pipeline dilemma is ‘a political choice… I believe that our geopolitical interests are such that we could find some projects, infrastructure…pipelines…that would create an impetus for preserving the territorial integrity of Russia’.67 In this case China may represent a serious geostrategic challenge for the Russian Federation. For instance, the ‘economic superiority [of China] will be so evident that sooner or later, we will see an aggravation of political issues [moreover] in the Far East regions, we have several million illegal migrants from China’.68 The Russian government is also pushing the privately owned Caspian Pipeline Consortium (CPC, www.cpc.ru) to increase its pipeline capacity from the initial 22 million tonnes to 67 million tonnes a year in order to add additional volumes of Russian oil into the CPC pipeline. Stephen O’Sullivan, co-head of research at United Financial Group in Moscow, mentioned other prospective oil infrastructure projects: „ Druzhba oil pipeline (Adria – 100kbd, Odesa–Brody – 180kbd, total – 1.7mbd) „ Murmansk pipeline and sea terminals (1.6–2.4mbd) „ extension of Black Sea oil terminals (1.6mbd) „ Sakhalin pipelines to Japan (400kbd).69 According to the Russian Energy and Industry Minister, Viktor Khristenko, Russia may increase oil exports by 27 per cent by 2015 as Transneft, the state-owned oil pipelines monopoly, plans to dramatically increase its

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pumping capacities by 30 per cent by 2015. Therefore, oil exports may reach 330 million tonnes (or 6.6 million b/d) in 2015. CDU TEK, the Energy Ministry’s Central Dispatch Unit, estimated that Russian oil production in September 2005 was as high as 9.38 million b/d.70 Official optimism was shared by Adam Landes, an energy analyst from Renaissance Capital (Moscow), who predicted that ‘Transneft will remain prominent because of the company’s increasing transparency and because of plans to increase its capacity’.71 In fact, Transneft’s export capacity may rise to 6 million b/d by the end of 2004 as it finishes Phase Two of the Baltic Pipeline System (BPS), the Adria reversal project, and the Butinge expansion. Landes concluded that Transneft needs to double its export capacity in order to meet the demand of the Russian oil sector.72 However, the fact that the development of oil export infrastructure may only be positive in the case of high oil prices and the growing demand for this fuel worldwide must be taken into account.

Gas transportation issues All Russian gas pipelines are linked to the Russian Unified Gas Supply System (UGS), which is managed by Gazprom. UGS has around 152,000km of natural gas pipelines.73 The Energy Charter Secretariat estimates that the ‘average age of trunk gas pipelines is nearing 22 years; 15 per cent having passed their depreciation (design) life (33 years) and 64 per cent have been in service for 10–32 years’ which is a source of major investment concern for the Russian gas industry.74 However, strategic export pipelines are generally in better condition than local low-pressure gas infrastructure.

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The gas pipeline infrastructure is managed according to the federal law On Major Pipeline Transmission (now under revision by the Russian parliament), which also regulates the access of independent gas producers to Gazprom’s transportation system. The pipeline regulations are a source of major concern for the companies investing in the independent gas-producing projects in Russia; according to the current ‘rules of the energy game,’ foreign investors are not expected to have a ‘free hand’ in the pipeline projects, which may jeopardize the security of energy supply. For example, a US international affairs analyst, Ariel Cohen, linked the US security of energy supplies with the presence of privately owned pipelines in Russia.75 It is also believed that the best policy response to the risk of gas cartelization is the ‘privatization of gas reserves and gas transport networks in producer countries’.76 Obviously, this area remains the cornerstone of Moscow’s national energy policy. The Russian government has decided to keep control over strategic oil and gas pipelines and, therefore, regulates production and export activities. Gazprom has also managed to establish the single export gas channel for LNG and pipelines projects in the Russian Far East by signing agreements with Shell-led Sakhalin-II for coordinated LNG deliveries and by channelling future gas exports from the TNK-BP-controlled Kovykhta field in Eastern Siberia to the Gazexport (a Gazpromaffiliated company) pipeline system. Gazprom emerges as an almost exclusive buyer of Central Asian gas: the company bought 19bcm of natural gas in 2005, and expects to purchase over 25.8bcm in 2006: its exclusive contract with Turkmenistan undermined attempts by Ukraine’s Naftohaz to emerge as a potential major supplier to the European gas market.

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deed, Russian Energy Strategy 2003 put the integration of Central Asian hydrocarbon resources into Russia’s energy balance as one of the major strategic goals: it may help Moscow to avoid investing a substantial amount of money in northern, still underdeveloped and expensive gas fields (eg Shtokman) and to eliminate unnecessary competitors. This concurs with the estimates of Shell Global Scenarios to 2025: the company analysts predicted that even in the case of full liberalization of Russian oil and gas markets, Moscow will retain its monopoly over the strategic oil and gas export pipelines. To proceed with its ambitious gas policy, Russia needs to improve its gas pipeline system in order to build new LNG terminals (Sakhalin-II project operated together with Shell (9.6 million tonnes of LNG per year) and Shtokman (16 million tonnes of LNG per year)) to diversify its export route. For example, in September 2005, Russia delivered 60,000 tonnes of LNG to the United States on the basis of swap contracts with Shell and British Gas Group. In fact, the United States, together with Japan and South Korea, are thought to be the main consumers of Russian LNG, while

In fact, Gazprom has already bought 12.5 per cent of the Central Asian gas reserves (8tcm) under long-term contracts signed in 2002–2003. Gazprom restricted access of Central Asian national gas companies to its transmission system, impeding their ability to sell directly to European buyers’.77 Therefore, in the very near future, Russia also plans to gain control over the promising gas and oil resources of Kazakhstan and Turkmenistan. Moreover, the Kremlin is said to be openly interested in the final determination of the legal status of the Caspian Sea, the involvement of Russian companies in the hydrocarbon infrastructure, exploration and production activities in the CIS, and investment in the FSU’s fuel-energy sector. Gazprom is also expanding on the international stage with its participation in the development of future Iranian pipeline projects that would bring gas to India and Pakistan and, therefore, eliminate a dangerous competitor on the European gas market. Furthermore, this trend explains Moscow’s reluctance to ratify the Energy Charter Transit Protocol as it allows third-party access to the Russian pipeline infrastructure. In-

22 112189

13

6

72

4

1 66

63 184

4

139

2002

13 44

4 29 57

1 52

4

19 10 40

59 6 64

6

72 2030

Figure 4.2. Major net inter-regional natural gas trade flows (2002 and 2003, bcm) Source: World Energy Outlook 2004© OECD/IEA, 2004, Figure 4.9, p. 143.

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Russia also reconsidered its gas and transportation policy in the CIS: during the August 2005 summit of CIS countries in Kazan (Russia), the Kremlin made a political volte-face by denying disloyal regimes low gas prices and switching to more ‘pragmatic’ market-based relations. The early days of 2006 saw Gazprom demand an astounding US$230 per 1,000cm of gas supplied to Ukraine, a huge hike from the US$50 previously paid. As a result of various machinations, Ukraine now pays US$95 per 1,000cm. However, Gazprom gas giant failed to gain control over the Ukrainian gas transmission system – a major transit corridor for Russian gas exports – and it still uses the opaque intermediary (RosUkrEnergo – a Swiss-registered company which is actually 50% owned by Gazprom) in its trade relations with Ukraine.

Russian oil exports to the United States are predicted to increase and reach 10–13 per cent of US consumption. The most significant non-LNG infrastructure projects are: the recently completed Blue Stream pipeline bringing 14.35bcm of gas to Turkey; the Yamal–Europe pipeline running through Belarus and Poland, reaching its full capacity of 33bcm/ year in January 2006; the launch of the US$5.7 billion off-shore Northern European pipeline consortium controlled by Gazprom (51 per cent), EON (24.5 per cent) and BASF (24.5 per cent). This last pipeline, due to be operational in 2010, will bring 27.5bcm of gas to Germany with a total projected capacity of the project exceeding 55bcm. It is possible that this project was influenced by the former German chancellor Schroeder, whose recent appointment underlined the new tendency of employing highprofile Western managers.

North-European Gas Pipeline

Denmark

Bal ti

North Sea United Kingdom

cS

ea

Vyborg Estonia Latvia

Russia

Lithuania

Grayfsvald

Netherlands Belgium Germany

France Switzerland

The Main Characteristic of Vyborg Grayfsvald section Annual total capacity - 55 bcm/y Czech Rep. - 1189 km Length - 42 in Diameter - 22 Mpa Pressure Austria

UKRAINE Slide 9

Figure 4.3. North European gas pipeline Source: Presentation of Mr. E. Zayashnikov, Member of the State Duma at Eurogas/DG TREN conference ‘The European Single Market in the Global Dimension’, www.eurogas.org .

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Energy dependence of foreign states on Russian gas exports Table 4.1. Countries with high dependence on Russian gas Country

Gas deliveries from Russia (bcm)

Share of Russian gas in Share of Russian gas total gas consumption (%) in total gas imports (%)

Moldova

2.7

245.5

100.0

Serbia and Montenegro

2.3

100.0

100.0

Estonia

0.9

100.0

100.0

Bulgaria

3.1

99.6

100.0

Finland

4.3

99.2

100.0

Latvia

1.5

93.8

93.8

Lithuania

2.9

93.2

93.5

Greece

2.2

90.0

80.0

Slovakia

5.8

85.6

79.5

Czech Republic

6.8

76.5

69.4

Hungary

9.3

71.5

84.9

Turkey

14.5

65.3

65.3

Austria

6.0

63.5

76.9

Belarus

10.2

55.3

51.5

Table 4.2. Countries with average dependence on Russian gas Country

Gas deliveries from Russia Share of Russian gas in total gas (bcm) consumption (%)

Share of Russian gas in total gas imports (%)

Ukraine

34.3

48.5

50.4

Poland

6.3

47.6

69.2

Germany

37.3

48.5

50.4

France

13.3

29.8

29.8

Italy

21.6

29.5

35.2

Table 4.3. Countries with low dependence on Russian gas Gas deliveries from Russia (bcm)

Share of Russian gas in total gas consumption (%)

Share of Russian gas in total gas imports (%)

Romania

4.1

21.8

69.5

Switzerland

0.3

10.0

10.3

The Netherlands

2.7

6.2

19.9

Croatia

0.4

n/a

36.4

Country

Source: Kommersant Business Guide Oil and Gas 14 December 2005; Gazprom data 2005; BP Statistical Review of World Energy 2005; IEA Energy Statistics of non-OECD countries 2002–2003

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Conclusion

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he Russian energy sector, accounting for 25 per cent of the country’s GDP and dominating the Moscow Stock Exchange will increase in political and economic significance. It will remain the Kremlin’s top priority for decades to come and it will empower the Russian presidency to achieve its major strategic goals: the economic, political and social modernization of the country. Initially the development of the Russian energy will result in a sound economy and substantial GDP growth; however, sooner or later, Russia may face a ‘resource curse’ (‘Dutch disease’, economic inefficiency, corruption etc). Energy will remain both a means and an end for the Kremlin’s foreign policy, Russia’s instrument of comparative advantage in the 21st century. It would seem that the Russian government would use energy as a geopolitical lever in its relations with Europe, the United States, Japan and China and use mutual energy interdependence with these countries to establish closer economic and political ties, to use dialogues with major energy-producing and consuming areas to strengthen its political and economic power. Moreover, Russia will look for new markets for its oil and gas exports and will try to diversify its energy exports to avoid political/ economic pressure and a high level of dependency on one consumer (eg the EU). The future of energy cooperation with China is still unclear, while the energy dialogue with Japan will lead to rapprochement between Moscow and Tokyo. The US–Russian energy dialogue seems to be a promising area of cooperation, but it may be restricted

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by political pressure coming from Washington and the uncertain investment and legal climate in Russia. The Kremlin also intends to play a significant role in maintaining the international regime of security of energy supplies. The Russian leadership has established a clear aim to become a world leading energy producer and use the export of natural gas/LNG as a political tool. In fact, the long-term contracts for natural gas and LNG promote stability and responsibility in the buyer–seller bilateral relationship and can foster regional geostrategic stability and political partnership between two countries (see, for instance, the Japanese utilities companies signing long-term contracts with Sakhalin Energy for LNG shipping and, therefore, promoting bilateral relationships between Tokyo and Moscow). However, the country’s capacity to exert monopolistic power will be limited by alternative oil and gas suppliers. Inside the country, the Kremlin is developing a coherent energy policy, with which Russian private oil companies, independent gas producers and foreign investors must comply. The state will continue to control the main export pipelines (via Transneft and Gazprom) as well as major energy assets in order to be able to fulfill its main export priorities. Nevertheless, Russia must expect the energy and oil markets to be gradually liberalized, and after accession to the World Trade Organization, internal energy prices are expected to rise in order to make investment in internal energy assets (independent gas production and distribution, power generation, etc.) profitable. Thus, the Russian government is likely to favour M&As

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and portfolio investment in the energy sector, but will keep strategic control over the fuel-energy complex. Analysts predict stricter legislation and an increase in the tax burden. Production Sharing Agreements (PSAs) will be tolerated only in exceptional cases, such as Sakhalin and Shtokman, when national producers have neither financial possibilities nor sufficient technological bases to develop these fields. Henceforth, the difficulties with launching new

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PSAs suggest that it will not be a dominant component in FDI unless Russia is confronted with low oil prices. Despite the presently low level of FDI in Russia, the general climate for portfolio strategic investment in the oil and gas sector will be favourable for foreign investors, which will consequently catalyze democratic developments, further liberalization and diversification of the national economy.

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Notes and references 1 2 3 4

5 6 7 8 9

10 11 12

13 14

15 16

17

18 19 20 21

Russian Energy Strategy to 2020, Moscow, 2003. World Energy Outlook 2004, p31. Russian Energy Strategy to 2020, Moscow, 2003. D.Trenin’s speech, an overview, New Tendencies in Russia’s Foreign Policy, 25 February 2004, and D.Trenin and A.Kuchins (eds.), Rossiya – Blizhaishee Desyatiletie, Moscow Carnegie Center, Moscow, 2004. C. G. Gaddy, ‘Perspectives on the potential of Russian oil’, Eurasian Geography and Economics, 2004, No. 5, p. 351. D.Trenin, ‘Identity and integration: Russia and the West in the 21st century’, Pro et Contra, Moscow, 2004, 8(3): 12. Ibid. ‘A survey of Russia’, The Economist, 22 May 2004, p18. F. Hill, ‘Energy Empire: Oil, Gas and Russia’s Revival’, The Foreign Policy Centre, September 2004, p. i. Downloaded from www.fpc.org.uk E.Chow, ‘US–Russia energy dialogue: policy, projects or photo op?’ Foreign Service Journal, December 2003, p34. Forbes, 28 April 2003, 171(9): 84. ‘Russia rising as energy superpower on US demand,’ The Moscow Times, 26 October 2005, p13. See also The Geopolitics of Natural Gas, Baker Institute Study No. 29, March 2005; I. Gorst, Russian Pipeline Strategies: Business versus Politics, Baker Institute, October 2004. Ibid. D.Goldwyn, The United States, Europe and Russia: Toward a Global Energy Security Policy, East West Institute Policy Brief, August 2002, 1(5): 2. Ibid. See, for example, Belyi, Andrei, ‘Des aspects stratégiques du partnériat énergétique entre la Russie et l’Union européenne et leurs limites’, in De Wilde, Tanguy. Spetschinsky, Laetitia (eds). La Politique étrangère russe et ses implications pour l’Union européenne, Bruxelles : Peter Lang, 2004, pp. 201–224. Coby van der Linde, ‘Energy in a changing world’; inaugural lecture as professor of Geopolitics and Energy Management at the University of Groningen; Clingendael Energy Papers No. 11, CIEP 03/2005, pp. 10–11. Ibid. Ibid. For more details, see www.shell.com Quoted in The Geopolitics of Natural Gas, Baker Institute Study No. 29, March 2005, p3.

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22 23 24

25 26 27 28 29 30 31 32 33 34 35 36 37

38 39 40 41

Ibid. ‘Russia rising as energy superpower on US demand’, The Moscow Times, 26 October 2005, p13. S. Boussena et C. Locatelli, ‘Vers une plus grande cohérence de la politique pétrolière de la Russie’, Revue de l’Energie, n° 560, octobre 2004, p. 511. See Russia: New Estimates Put Oil Reserves Much Higher, Oxford Analytica, 18 May 2004. E.Chow, ‘Russian pipelines: back to the future?’, Georgetown Journal of International Affairs, Winter 2004, 5: 27–34. Alfa Bank Corporate and Industry News, March 2005. Quoted in A.Ostrovsky, ‘Winners and losers in Kremlin’s grab for oil’, Financial Times, 6 November 2006. Baker & McKenzie, CIS Energy Notes, September 2003, p11. Ibid. Quoted in The Strategic and Geopolitical Implications of Russian Energy Supply, Security, and Pricing, p6. Ibid. World Energy Outlook 2004, Brunswick UBS data, 2004. Brunswick UBS data, 2004. World Energy Outlook 2004, p88. ‘Russia: New estimates put oil reserves much higher’ Oxford Analytica, 18 May 2004. In 2003 Yuganskneftegaz’s proven reserves (according to an SPE audit) amounted to 11.63 billion barrels, and its production capacity – 1.015 million barrels per day (Source: www.yukos.com/EP/Yuganskneftegaz.asp , information provided by Professor Thomas Waelde). Rosneft bought this asset for $9.4 billion which was an extremely good deal. Undoubtedly, Yuganskneftegaz’s takeover fits the Kremlin’s policy of bringing back key oil assets ‘lost’ in mid-1990s. Ibid. World Energy Outlook 2004, p306. Ibid. p304. Quoted in US–Russia Energy Summit Executive Seminar: The Strategic and Geopolitical Implications of Russian Energy Supply, Security and Pricing, Baker Institute Study No. 23, October 2003, p3. Also see A.Landes, Russia Oil and Gas: Upstream Economics, Moscow, Renaissance Capital, 2003.

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42 43 44

45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62

38

World Energy Outlook 2004, p303. ‘Russia: Investment is needed if oil output is to rise’, Oxford Analytica, 7 July 2005. Brenda Shaffer from Harvard University particularly underlined the importance of FDI in the Russian energy sector for global energy security. See B.Shaffer, Russia’s Role in the Shifting World Oil Market, Caspian Studies Programme Policy Brief, No. 8, May 2002, p1. Lukoil, 2005. Kommersant Oil and Gas, 14 December 2005. World Energy Outlook 2004, p36. Quoted in ‘OPEC exploring oil in Moscow’ by Sergey Minaev, Kommersant Daily, 26 December 2005. Russian Federation: Investment Climate and Market Structure in the Energy Sector, Energy Charter Secretariat, Brussels, 2005, p121. E.Chow, US-Russia Energy Dialogue: Policy, Projects, or Photo Op? p38. Ibid. p2. Brunswick UBS data, 2005. Alfa Bank research, April 2005. ‘Russia: Stated-owned firms are set to dominate oil’, Oxford Analytica, June 22, 2005. ‘Russia rising as energy superpower on US demand’, The Moscow Times, 26 October 2005, p13. BP Review of World Energy 2005. Quoted by Irina Rybalchenko ‘Un-equivalent fuel’ Kommersant Daily, October 19, 2005. Russian Federation: Investment Climate and Market Structure in the Energy Sector, Energy Charter Secretariat, Brussels, 2005. Ibid. Alfa Bank research, 2005 Transneft data-2005, CIA, The World Factbook 2005, Energy Charter Secretariat – 2005. E.Chow, ‘Russian pipelines: back to the future?’ Georgetown Journal of International Affairs, Winter 2004, p28.

63 64 65 66 67 68 69

70 71

72 73 74 75

76 77

S.Sestanovich, A conversation with Simon Kukes, transcript, Council on Foreign Relations, New York, 9 February 2004, p7. ‘A survey of Russia’, The Economist, 22 May 2004, p18. Author’s interview with Jack Matlock, Salzburg, Austria, June 2004. E.Chow, ‘Russian pipelines: back to the future?’, Georgetown Journal of International Affairs, Winter 2004, 5: 30. Quoted in The Strategic and Geopolitical Implications of Russian Energy Supply, Security, and Pricing, p5. Ibid. p5. For more information, see S.O’Sullivan, License to Drill: Russia’s Oil Boom Continues, United Financial Group, 2003; S.O’Sullivan, Outlook for Russian Oil and Gas, United Financial Group, Moscow, 2002. M.Teagarden, ‘Crude exports to rise by third’ Bloomberg, The Moscow Times, 1 November 2005, p5. Quoted in US-Russia Energy Summit Executive Seminar: The Strategic and Geopolitical Implications of Russian Energy Supply, Security and Pricing, Baker Institute Study No. 23, October 2003, p3. Ibid. The World Factbook 2005, CIA. See Russian Federation: Investment Climate and Market Structure in the Energy Sector, Energy Charter Secretariat, Brussels, 2005, p113. A.Cohen, ‘A private Russian oil pipeline is good for US energy security’, The Heritage Foundation Executive Memorandum, 14 March 2003. Quoted in The Geopolitics of Natural Gas, Baker Institute Study No. 29, March 2005, p10. World Energy Outlook 2004, p160.

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About the series: Russian foreign energy policy reports

T

his series of reports establishes for the first time the confluence of Russian foreign policy with the acquisition of foreign energy assets by Russian entities. Nine specific country profiles focus on the oil, gas, electricity and nuclear power industries. Each report, written by an author of international standing, explains how Russian foreign energy downstream mergers and acquisitions are transpiring to consolidate the new Russian empire. These unique studies address many questions of substance for energy industry professionals, investors, policy experts, and decision makers who seek to make sense of the dynamic changes that have overcome the Russian energy complex and altered the balance of global energy geopolitics. Series Editor Dr. Kevin Rosner, PhD is a specialist in Russian oil and gas, security of critical energy infrastructure, and international energy security policy. He served as the 2006 Co-Director of the NATO Forum on Energy Security. He is a Senior Fellow, both at the UK Defence Academy and at the Institute for the Analysis of Global Security (IAGS) in Washington DC. Posts held include Senior Security Advisor to the Baku-Tbilisi-Ceyhan pipeline company, Project Director with the Programme on Cooperation with the Russian Federation at the OECD, and Project Manager with the UNESCO Science Division in Paris. Dr. Rosner is the founder of Therosnergroup®, serving leading members of the global oil and gas community with energy and security analytical products.

‘Russian Involvement in Eastern Europe’s oil, Petroleum Industry: The Case of Bulgaria’

T

Adnan Vatansever

his report answers questions such as: as one of the largest foreign acquisitions by a Russian company occurred in Bulgaria, what lessons are applicable to charting future Russian downstream takeovers? Why have Eastern Europe and Western FSU countries been the primary focus of Russian acquisitions? What drives LUKoil (and other Russian oil companies) to pursue acquisition of assets in these regions? Finally, what is the stance of the Russian government in terms of promoting such acquisitions abroad? Adnan Vatansever is a freelance energy consultant and the author of a number of reports for Cambridge Energy Research Associates. He is currently in the process of completing his Ph.D. dissertation on Russia’s energy sector at the Paul Nitze School of Advanced International Studies, Johns Hopkins University. He holds a B.A. in International Relations from the Middle East Technical University in

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Russia

Ankara, M.A. in Russian and East European Studies from Georgetown University’s School of Foreign Service. Hardcopy ISBN 1-905050-40-2 E-report ISBN 1-90505080-1

‘Kazakhstan: Energy Cooperation with Russia – Oil, Gas and Beyond’ Dr Ariel Cohen

T

his important study explains how Russia, with its private sector and policy makers working in tandem, has exerted a significant amount of control over Kazakhstan’s vast natural resources and its economic freedom. It looks at the way Russia and Kazakhstan agreed to divide the Caspian Sea shelf and how Kazakhstan has managed to maintain good relations with Moscow overall, despite its insistence on exporting energy resources to China and Europe directly and its hopes to export through Iran. Ariel Cohen, L.L.B., Ph.D., is an international expert in international security/ terrorism; Russian, Eurasian, European and Middle Eastern foreign, security, economic and business policy. He is Senior Research Fellow in Russian and Eurasian Studies and International Energy Security at the Davis International Studies Institute at the Heritage Foundation. Dr. Cohen has conducted conferences and briefings for the US Government departments and agencies. He appears on major US and foreign TV networks. Dr. Cohen also has extensive experience consulting for the private sector, international organizations, and technical assistance projects in the Central and Eastern Europe and CIS regions. Hardcopy ISBN 1-905050-41-0 E-report ISBN 1-905050-81-X

‘Georgia: Russian Foreign Energy Policy and Implications for Georgia’s Energy Security’ Liana Jervalidze

T

his report shows that as Georgia has restructured its energy sector, the new Russian and Georgian political elites exerted their influence, particularly through the participation of Russian gas company Itera in privatizations of Georgian gas enterprises. And how, over the past few years, Russian–Georgian business groups with their offshore capital have been working to monopolise the Georgian economy and Russia’s gas industry has been consolidating its hold over the CIS pipeline infrastructure, particularly through the expansion of Gazprom. However, Gazprom failed to take control of Georgia’s pipeline infrastructure and Georgia is insistent on developing its pipeline potential in order to boost its role as a transit route to Europe, Turkey and Iran. Liana Jervalidze has worked with several government and research institutions working on Caspian region energy policy and development. She has advised private

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sector companies in on the development of east-west energy corridor and Georgia’s potential role in regional integration. Since 2003, Ms.Jervalidze has been working on the development of Georgia’s gas market. She has spoken on regional energy policy at international conferences in the CIS, Europe and the US. Her analyses have been published in both Georgian and English. Hardcopy ISBN 1-905050-35-6 E-report ISBN 1-905050-84-4

‘Russia’s Energy Interests in Azerbaijan’

I

Fariz Ismailzade

n 2003–2004, an increased number of senior Russian officials and major energy companies, such as Itera, Gazprom and RAO UES visited Baku in the hopes of participating in energy projects in Azerbaijan. While maintaining diplomatic relations with Moscow, Azerbaijan is more hesitant when it comes to close cooperation with Russian energy companies. Baku fears that if Russia gains more assets in Azerbaijan, control of these assets will be used for political purposes. This unique study looks at the confluence of Russian private and public sector interest Azerbaijan’s energy sector. Fariz Ismailzade works with the International Republican Institute in Baku and is a part-time lecturer at the department of political science at the Western University in Baku. He holds an MA in Social and Economic Development from Washington University, St. Louis, and a BA in Political Science from Western University, Baku. Hardcopy ISBN 1-905050-42-9 E-report ISBN 1-905050-87-9

‘Ukraine: Post-revolution Energy Policy and Relations with Russia’

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Olena Viter, Rostyslav Pavlenko and Mykhaylo Honchar

his report looks at how the new Ukrainian government plans to decrease Russian influence over Ukraine’s energy sector. President Viktor Yushchenko has declared goals which include the diversification of oil and gas supply sources, the reform of the domestic market, and the creation of a strategic oil stock. Ukraine’s search for more partners in the energy sphere has affected the relationship between Ukraine and Russia; from a “brotherly” relationship to one of pragmatic interest. Olena Viter is a Senior Adviser to the Operational Department of the Secretariat of the President of Ukraine. She is Coordinator of Energy Programs at the School of Policy Analysis, National University of Kyiv-Mohyla Academy, and a member of the non-governmental Expert Council on Energy Security. In 2002, she was an intern at the Hudson Institute, and in 2003 she participated in drafting Ukraine’s Energy Strategy. Rostyslav Pavlenko, PhD (Political Science), is Head of Situation Analysis Service of the Secretariat of President of Ukraine. Dr Pavlenko is also an associate professor

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of Political Science at the National University of Kyiv Mohyla Academy. He is the author of more than 400 publications, including over 40 scientific publications. Since 1999, he has served as an editor of the Political Science Section of Person and Politics, a social and legal magazine. Mykhaylo Honchar is Deputy Chairman of the Board of Ukrainian JSC “Ukrtransnafta”. He also serves as Vice President of the non-governmental “Strategy-1” Foundation. Between 1994 and 2000, he worked in the Council of National Security and Defence, National Institute for Strategic Studies. Mr. Honchar is the author of numerous articles and papers on energy and security issues. Hardcopy ISBN 1-905050-31-3 E-report ISBN 1-90505077-1

‘Turkmenistan-Russian Energy Relations’ Gregory Gleason

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urkmenistan has large gas reserves, but as its immediate neighbours have little import demand, Russia holds the key to its gas transport. In April 2003 Turkmenistan and Russia concluded a 25 year transport and marketing agreement for Turkmen natural gas. The new arrangements permit Turkmenistan’s gas production to reach 100,000 million cm per year in 2007. This unique study details the background and looks at the prospects for Turkmenistan’s gas production and export in the context of Russian strategy, and at Turkmenistan’s role in the new energy strategies throughout Eurasia and the Middle East. Gregory Gleason, Ph.D., is an internationally recognized expert in energy policy and international relations. A professor of political science and public administration at the University of New Mexico, Dr. Gleason has extensive field experience in Turkmenistan and the other countries of Eurasia and Central Asia. He has served as a consultant to Lawrence Livermore National Laboratory, Sandia National Laboratories, the Asian Development Bank, and the US Agency for International Development. His research has been sponsored by the National Science Foundation and the National Academy of Sciences as well as other public and private foundations. Hardcopy ISBN 1-905050-33-X E-report ISBN 1-905050-82-8

‘Belarus: Oil, Gas, Transit Pipelines and Russian Foreign Energy Policy’ Dr Margarita M Balmaceda

B

elarus relies on Russia for about 85% of its total energy needs, while Russia needs Belarus’ oil and gas pipelines to export its supplies to Western Europe. How will energy exports from Russia and Belarus’ transit capabilities impact Western Europe if this interdependent relationship ends, either through political changes in Belarus or if Russia ends its energy subsidies to Belarus? This report

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looks at transit, infrastructure and investment issues and analyzes both the state of the current infrastructure, as well as the possibilities this transit opens to Western investors, particularly as the Yamal Pipeline nears completion. In addition, it looks at the current conflict between Belarus and Russian investors for control of the country’s gas transit system and oil refineries. Margarita M. Balmaceda is Associate Professor at the John C. Whitehead School of Diplomacy and International Relations, Seton Hall University, New Jersey, and an Associate of Harvard University’s Davis Center for Russian and Eurasian Studies and the Harvard Ukrainian Research Institute. She received a Ph.D. in Politics from Princeton University (1996), and Post-Doctoral training at Harvard University. She has published widely on Russian, post-Soviet and East European energy and foreign policies. Hardcopy ISBN 1-905050-34-8 E-report ISBN 1-905050-83-6

‘Gazprom and the Russian State’

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Dr Kevin Rosner

azprom is the world’s single largest producer of natural gas, long acknowledged as a state-within-a-state. In 2005 it reached a turning point in its history when the Russian government reasserted its majority stakeholder position, whilst also continuing its own push to gain control over an increasing share of Russia’s energy complex overall. This timely report provides answers to questions such as: what do these movements mean for the future of the Russian energy sector? What will be the impact of state control over Gazprom on domestic and foreign shareholders? And what do these changes portend for the future of natural gas exploitation, production, distribution and the ultimate export of Russian gas to downstream consumers? And what will these changes mean to world? Hardcopy ISBN 1-905050-30-5 E-report ISBN 1-905050-85-2

‘Baltic Independence and Russian Foreign Energy Policy’

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Dr Harold Elletson

stonia, Lithuania and Latvia are uniquely dependent on the Russian Federation for energy supplies. The security of energy supplies are national security issues in the three ex-Soviet republics, which are now part of the EU. Increasingly dependent on Russian gas imports and with negligible sources of domestic energy supply, the Baltic countries have been the target of aggressive Russian commercial activity and a sustained attempt to lock them into a long-term reliance on Russia. Now, as Baltic political leaders, energy specialists and intelligence analysts consider their options, the implications for the security and independence of the three Baltic States are a matter of concern well beyond the Baltic. This important report will be essential reading for anyone with an interest in the future energy supplies of both the Baltic States and eastern Europe.

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Russia

Dr Harold Elletson leads The New Security Programme, which conducts research into the implications of the new security environment. He was previously Director of the NATO Forum on Business and Security. A former Member of the UK Parliament, he served as Parliamentary Private Secretary to the Secretary of State for Northern Ireland and as a member of the Select Committee on Environment. An international public affairs consultant and a fluent Russian speaker, he has advised many leading companies on aspects of their business in the former Soviet Union, including BP in Azerbaijan and Alstom in Siberia. Hardcopy ISBN 1-905050-36-4 E-report ISBN 1-905050-89-5

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GMB Publishing