Russia's oil boom may be running on empty

McClatchy NewspapersAugust 22, 2008 

MOSCOW — The Russian oil boom, which has produced a gusher of cash, political power and an opulent elite — and has helped fuel the country's renewed assertiveness in Georgia and elsewhere — is on shakier ground than officials in Moscow would like to admit.

Most of the oil produced after the country's 1998 financial collapse has come from drilling and re-drilling old Soviet oil fields with more advanced equipment — squeezing more black gold out of the same ground — and efforts to develop new fields have been slow or non-existent.

That strategy is potentially disastrous, said Valery Kryukov, who researches oil companies in western Siberia for a government-funded think tank.

"If the situation which exists now stays the same, oil production will start to decline seriously in two years," Kryukov said in a phone interview from his offices in the city of Novosibirsk.

The implications extend far beyond Russia's borders. Last year, Russia was the world's second-largest oil producer. If its output begins to decline or is hampered by inept or corrupt business practices, the price of oil could begin climbing again.

The concerns about Russia's oil industry also raise questions about the health of the nation's economy, which has enjoyed stratospheric growth thanks to high oil prices since the economic crisis a decade ago, according to interviews with a dozen economists and analysts.

Higher oil and gas prices could further enrich and embolden resurgent Russia, but if production declines sharply, a hungry bear could prove to be even more troublesome than a prosperous one is.

That's a serious matter for a country where, by some estimates, the oil sector funded about a third of the national budget last year, and where by all accounts industrial, technological and agricultural businesses lag far behind. Russia's other major revenue source is natural gas, in which Russia leads the world; oil and gas sales are mainly responsible for the country's $592 billion in gold and foreign exchange reserves.

The practice of reaping quick profits and ignoring long-term interests is reminiscent of the former Soviet Union's development policies, and it was embraced by post-Soviet billionaires, known as oligarchs, who propped up flimsy companies to strip Russia's natural resources for as many fast rubles as possible. It continued as the government took over many of those private companies, often by brutish means.

Under Vladimir Putin, Russia's president from 2000 to 2008 and now the prime minister, the Russian government dismantled the nation's largest oil firm, Yukos, and imprisoned its founder.

The government declared oil to be part of a "strategic sector" in which foreign investors need permission from the government before they can buy a significant stake in companies. Foreigners have been steadily shoved out, including a recent incident in which the head of the joint Russia-UK company TNK-BP, one of the country's leading oil concerns, and 148 specialists left the country after their visa status was called into question.

In the short-term, business has been lucrative: Russian oil output jumped from about 6.1 million barrels a day in 1998, when the price of a 42-gallon barrel was less than $20, to an average of some 9.7 million barrels a day in the first half of this year. Prices reached $145 a barrel in July before dropping back to the $120 range.

At its current rate of production, though, Russia will run out of oil relatively soon, in about two decades, according to BP statistics. Saudi Arabia — last year's biggest oil producer — can continue pumping at its current clip for about 70 years, according to the same BP statistics.

A chart provided by the U.S. Energy Information Administration lays out the stark details: Only two of Russia's 14 largest oil producing fields were opened after the Soviet Union collapsed in 1991, and half of the 14 were more than 60 percent depleted in 2006. As fields are depleted, pumping oil out of them generally becomes harder and more expensive.

After a decade of oil production increases, there's been a slight drop — 0.5 percent — in production during the first seven months of this year, according to state statistics. Troika Dialog, Russia's largest investment bank, is forecasting a 0.7 percent decline in oil production this year from 2007.

In response, Russian officials have rolled out a proposed tax break that could enable oil companies to save an estimated $4.2 billion or more in the hope that firms will use the cash to go find more oil.

Economists who are bullish about Russian oil point to upcoming projects on offshore sites — awarded to two state-controlled companies — that could substantially increase the country's oil reserves.

Officials in Russia's ministry of economic development didn't respond to repeated requests for comment.

However, Valery Tsvetkov, a deputy of the institute of market problems at the state-funded Academy of Sciences, laid out an array of statistics showing what's wrong with Russia's oil industry.

Among them: In 1990, some 17.3 million feet of new wells were drilled looking for new reserves in the former Soviet Union, almost all of them in what's now the Russian Federation. In 2007, about 3.9 million feet were drilled.

"Why? Because today those who work in the oil industry find it easier to take the cream off the existing fields than to find new fields," Tsvetkov said. When he and others send research papers to the government about potential economic problems, he said: "No one reads them."

"The Russian government has few people with the mentality of statesmen," Tsvetkov said. "Today, the aim of many people is to become rich at the expense of the state."

Indeed, there are few signs of concern in the nation's capital, a caviar wonderland for the Learjet crowd. Moscow has more billionaires than any other city in the world — 74 according to Forbes magazine. Lest the millionaires feel left out, there's an annual Millionaire Fair where a big spender can buy a $1 million set of diamond-encrusted rims for his Mercedes or BMW.

Even optimists, however, are worried about the economy's dependence on oil revenues during a time when reserves are ebbing.

Valery Nesterov, an analyst at Troika Dialog, showed a reporter a map of Russia's oil and gas infrastructure — a vast array of wells and pipelines — and gestured to blank expanses in the eastern provinces. The oil under the ground there and in the waters surrounding Russia could secure its position as a world leader, he said.

When asked about the current flattening of production numbers, and the extent to which Russia's economy is tied to oil, Nesterov's tone changed.

"Every Russian who thinks is worried about this. Unfortunately, there are no signs this will change," Nesterov said. "These days, the economy is dependent on natural-resource exports, which is just a temporary bonanza. These resources sooner or later will be depleted."

A Western diplomat in Moscow said drilling in old fields makes sense from the perspective of Russia's ruling elite, who control energy companies only as long as they remain in power.

"If you're running Gazprom (a Russian natural-gas producer) but you don't really own it, then your interest is maximizing short-term profits, not long-term development," said the Western diplomat, who spoke on the condition of anonymity because of the delicacy of the subject. "If you look at most of the Russian companies — the energy companies — that's precisely what's happened. They have focused on profits or dividends and less so on long term development and replacing reserves."

In a nation with a history of economic tumult and social unrest, the diplomat said, it doesn't bode well for the future.

"They're not Keynesians," the diplomat said, "they're Russians."

McClatchy Newspapers 2008

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