This article and the article titled "Russia's oil output expected to exceed official forecasts" comprise the first half of a two-part series updating the status of Russia's oil sector. This week, a top analyst looks at the various choices on energy policy facing Russia and what that portends for the global petroleum industry. Next week, the focus shifts to the perspective on Russian oil as seen by Russian major oil company OAO Yukos.
The Russian leadership confronts high-stake choices regarding the manner in which it will conduct energy policy in the months ahead. The choices made now will have far-reaching and lasting effects on the way Russia's immediate neighbors in the New Independent States (NIS), Europe, and the world community perceive her.
It is essential that Russian leaders not underestimate the gravity of decisions related to energy sector investment and energy exports. Simply put, Russia can use its control of oil, natural gas, and electric power supplies to try to dominate neighbors for short-term political or commercial advantage.
Alternatively, it can work cooperatively to forge beneficial relationships based on mutual respect, which could help Russia become a leader in international energy policy and business and help Russian companies obtain access to international capital. The farsighted decision would be the latter course, but unfortunately, statesmanship may yet yield to gamesmanship.
Russia has the oil and natural gas, the geographical position, and the technological expertise to move to the front rank in the international energy industry. The question is whether it can show the right leadership.
Western investment
Domestically, Russia needs to do more from a legislative standpoint in order to attract the Western investment necessary to expand its oil production base. It is essential to establish a working production sharing agreement (PSA) regime that makes Russia's oil and natural gas sector competitive with other countries for the investment dollars spent by multinational energy companies.
Last year, companies were heartened to hear Russian President Vladimir Putin express his strong support for completing the PSA-related framework. It has been said for almost a decade that more than $50 billion in foreign investment is waiting to enter Russia's upstream oil sector.
Slow progress in establishing an acceptable PSA regime, implementing specific types of legal guarantees such as the Normative Acts, and passing the new tax code have restricted foreign investment in Russia's upstream energy sector to a relative trickle thus far. The most immediate need and important issue will be Russia's track record in supporting the PSA projects already under way on Sakhalin Island
The development of Russian energy companies is equally important. Buoyed by high world oil prices, Russian oil companies such as Lukoil and OAO Yukos now have financial resources to conduct much-needed oil exploration and development work in a sector that stagnated in the 1990s due to lack of investment. Russian oil companies are even looking outside of Russia's borders for financing and new business opportunities. Tyumen Oil Co., for example, has received $500 million in financing from the US Export-Import Bank to purchase US petroleum equipment and technology. Other companies are seeking listings on European and US stock markets.
But continued moves to ensure transparency, shareholder rights, and conformity to international legal standards are key elements that will determine whether the internationalization of Russian oil companies will succeed. This progress by Russian companies will also depend, to some extent, on whether or not Russia as a country is viewed as a responsible participant in the international energy arena.
Export pipelines
Bringing Russian oil to world markets interests both Russian and Western companies. However, a single, state-owned entity, Transneft, which owns and operates the world's largest crude oil pipeline network, dominates oil transportation in Russia now.
Export quotas, tariffs, and other restrictions detract from the free flow of oil and the development of a competitive, cost-based environment in Russia's transportation sector. Transneft has not attracted foreign investment in projects such as the Baltic Pipeline System (BPS). Instead, it seeks to pay for the project-which will cost more than $2.5 billion-by increasing tariffs that Russian and Western oil companies pay trying to export their oil out of Russia.
An alternative and better approach would be to open Russia's oil transportation sector to private investment and to bring in Russian and Western companies to build, own, and operate large export projects such as BPS.
Energy will continue to fuel Russia's and the world's economic growth. Possessing the world's largest natural gas reserves and exporting more than 3 million b/d of crude oil and products, Russia has the power to affect regional and world oil markets. Russia's role as an energy supplier and transporter will grow if producer-consumer relationships are handled in a way that the world community perceives as reliable.
With respect to oil, Russia has already enjoyed the benefits of a cooperative approach with foreign partners. Russian cooperation with Western and regional partners in the Caspian Pipeline Consor- tium (CPC) venture to build a pipeline link from Kazakhstan through Russia to the Russian Black Sea coast is an example of successful and mutually beneficial cooperation. The CPC pipeline will begin carrying more than 500,000 b/d of Caspian oil to Western markets later this year.
Currently, Russian natural gas supplies account for about 30% of Europe's annual natural gas consumption, but Russia also has important energy relationships with nearby countries such as Georgia, Ukraine, Turkmenistan, and others in the Caspian and Baltic regions. The way in which Russia handles its energy relations with these NIS countries will be a paradigm for how it is viewed by consumers and investors in the international community.
Transparency, rule of law, contract integrity, and compliance with international standards are essential to establishing and maintaining the long-term relationships that would enable Russia to integrate itself further into the world economic community. Russia has made laudable progress toward these goals during the past decade.
One move that would signal Russia's positive engagement with its neighbors would be participation in the Baku-Tbilisi-Ceyhan (BTC) oil pipeline, which will export oil produced in the Caspian region to a Turkish port on the Mediterranean.
Participation in construction of the BTC pipeline would be another step, along with the CPC project, in making Russia a major player in the international energy business.
It could also earn Turkish good will by helping to manage the difficult issue of safe and reliable oil transportation through the Bosporus Straits. In addition, Russia would gain access to another facility for exporting its oil to world markets.
The BTC oil pipeline will play an integral part in the creation of a broader East-West transportation corridor for exports from the Caspian region to world markets; Russian participation in the project would boost the standing of Russian companies in the international business community.
Pressure
Unfortunately, some Russians are more tempted to wield power as monopolistic energy suppliers in regional markets in order to obtain certain desired political and commercial gains in some of the NIS countries. The most egregious example is Russia's interruption of natural gas supplies to Georgia several times.
In one recent case that still has repercussions, the Russian Customs Service prevented Russian firm Inneftegazstroy from fulfilling its legally binding natural gas sales contract with the US company AES Corp. and from supplying natural gas to two generation units at the Gardabani power plant near Tbilisi. Subsequently natural gas was offered by the gas brokerage firm Itera at a higher price and on more-limited terms. This appears to have occurred in spite of the fact that AES had fulfilled its contractual terms and insists that it was ahead in its payments of Russian duties.
High-level pressure from the Kremlin, in close coordination with certain Russian energy companies, reportedly has been behind these natural gas cutoffs.
Part of the motivation may be a view that AES, the US company operating a power plant in Georgia, in some way jeopardizes the plans of Russia's state-owned electric power company, Unified Energy Systems (UES), to export electricity through Georgia to markets in Turkey. However, the Turkish market is large enough, financial crisis notwithstanding, to absorb the exports of both UES and AES.
The gas cutoffs have also occurred against the backdrop of increasingly tense relations between Russia and Georgia on issues such as the closure of Russian military bases and the alleged presence of Chechen rebels in Georgia.
If Russia is in fact attempting to use energy exports for political pressure, then it will have sent a chilling message regarding the commercial reliability of its energy companies. This is a lesson that Russia's commercial partners in Europe and elsewhere would not soon forget.
Russia also has wielded its current monopoly on gas pipelines in the Caspian region. By some estimates, Turkmenistan holds the world's fourth largest natural gas resource base, and, historically, Russia's natural gas transmission grid, built to serve the Soviet Union, has been its only option for exporting this gas.
During the past several years, Moscow's control over natural gas export routes has allowed it to employ tough bargaining tactics, pressing Turkmenistan to accept prices for its natural gas that are far less than those for which the Russian gas firm OAO Gazprom resells that natural gas to European customers.
Meanwhile, Itera, whose cloudy connections with Gazprom are raising disturbed eyebrows among Gazprom board members, has tried to take over much of the natural gas and electric power infrastructure of Armenia and Georgia in predatory debt-for-equity swaps. If successful, such transactions would cede significant segments of these countries' energy infrastructure to Russian businessmen who may enjoy particularly close ties to political leaders seeking to use energy as a means of political pressure.
Mistrust or growth?
If Russia does not destroy its own credibility as an energy supplier, Europe's reliance on Russian natural gas can be expected to grow in the future, as the North Sea's reserves are depleted and LNG imports from the Middle East and Africa reach their natural limits.
As with the oil sector, however, Russia's upstream natural gas sector is in serious need of investment to develop the gas fields that will sustain Europe's future energy consumption needs. Fortunately, there are signs that Russia is making some moves, albeit very slowly, towards doing just this. Germany's Ruhrgas AG just boosted its equity holdings in Gazprom to 5%.
Further moves towards deregulating and privatizing the natural gas sector and towards restoring Russia's credibility as a supplier would be welcomed by Russian and Western investors, who then could work together much more productively to bring Russia's vast resources to market.
Russian leaders have a choice. On one hand, they can focus narrowly on exploiting monopolistic opportunities with respect to oil and natural gas exports-a trend that has persisted since Soviet times. In the early 1990s, Russian companies frustrated foreign producers' desires to depend on existing Russian pipelines to transport oil and gas to Europe, costing Russia an opportunity to be viewed as the preferred energy corridor, with the influence and earnings attending such a role.
Today, Russian leaders have another opportunity to help their companies become world-class players in the international energy industry by promoting the rule of law, the sanctity of contracts, and mutually beneficial producer-consumer relationships that are based on reliability and long-term trust.
By using energy-related cooperation to enhance both its development of partnerships and its relationships in other aspects of trade and commerce, Russia would go far in achieving its goal of becoming a major player in the world economy. Then it, and the world, can only win.
The author
Jan H. Kalicki is a public policy scholar at the Woodrow Wilson International Center in Washington, DC. He recently was counselor to the US Department of Commerce and served as US Ombudsman for Energy and Commercial Relations with the New Independent States in the administration of President Bill Clinton. Kalicki also has served as senior vice-president at Lehman Bros. in New York, chief foreign policy adviser to Sen. Edward M. Kennedy (D-Mass.), and a member of the US Department of State's policyplanning staff under Secs. Henry Kissinger and Cyrus Vance. He has taught at Brown, Georgetown, Harvard, and Princeton Universities.
"If Russia is...attempting to use energy exports for political pressure, then it will have sent a chilling message regarding the commercial reliability of its energy companies...a lessonellipsepartners in Europe and elsewhere would not soon forget," Jan Kalicki.
