Valery Kryukov
Novosibirsk, RussiaArild Moe
Lysaker, Norway
Liquidation of the Soviet production ministry structure governing the oil industry, has led to simultaneous transfer of administration to a lower level: local production associations.
These production associations have won almost complete freedom from previous dictates from the ministry level while preserving for themselves prerogatives in relation to units subordinate to them, as well as against possible intruders in their territories.
What kind of behavior can be expected from these "liberalized" production associations?
Their main goal will be to keep control of their territory and production capacities. This is rational. There is nothing sinister about it.
Quite another question is whether maximization of organization self-interest is beneficial to society at large. Usually it is not.
If the reforms fail to penetrate the structure all the way down, there is little reason to expect an effective turnaround in oil production.
AN ILLUSTRATION
An interesting illustration of behavior and interests of local production associations can be seen in developments in Nizhnevartovskneftegaz. It was responsible for 4.2 million b/d of oil when Samotlor field peaked in 1983 and produced 1.6 million b/d in 1990.
At the end of 1990 one of the production units, Chernogorneft, decided to leave the association and establish itself as an independent unit.
This was strongly contested and criticized by the production association, which has since done much to deny the new independent unit supplies of materials and technology.
But the production organizations are unlikely to remain completely content with the old compartmentalized structure.
A likely step will be to link up with transporters, refiners, and distributors and establish contact with end users.
VERTICAL INTEGRATION
Vertical integration is a rational, normal strategy that has been pursued by many oil producing companies elsewhere in the world.
However, in a Russian setting such a development entails a risk for society because such vertically integrated structures could become regional monopolies. The reason is that the infrastructure in place-refineries, pipelines, and distribution networks-was designed for a centrally planned economy with little or no extra capacity and alternative supply lines.
Within a new economic system this is the perfect basis for creation of new regional monopolies. It is quite evident that such monopolistic structures will have few incentives to reorganize production in a more efficient manner, significantly reducing waste and cost problems that have ridden the Soviet oil industry.
Creation of new vertically integrated structures is under way.
One is Lukoil, recently founded by a group of production associations in western Siberia-Langepas, Uray, Kogalym-and refineries in Volgograd, St. Petersburg, and Lithuania, The Moscow city council is also among the founders.
Undoubtedly such a structure can provide experience from new business ties and close contact between producers and consumers, an experience almost nonexistent in the old system.
But even such new and seemingly refreshing creations will have an inherent interest in preserving some of the features of the old system that are advantageous to them.
SINKO INDEPENDENT?
Another new creation is Sinko, the Siberian oil company that will be a holding company for several producers in small fields previously left untouched because of low prices paid to production associations for crude. With new prices and export possibilities, such fields constitute a considerable reserve.
But how "new" and "independent" is the new company?
Founders are mainly the old production organizations. Individual producers will be totally dependent on existing large production organizations for manpower and equipment.
Sinko was also given by decree, in the absence of any competition, priority rights to exploitation of 20 fields. Investments already made in the fields are written off.
This is a very advantageous basis for a new company. Sinko is selling shares to attract more domestic as well as some foreign capital.
Again we see a creation that may lead to use of resources previously neglected. But at the same time the organization is a product of the old structures. It can be regarded as an attempt by production organizations to take control of a niche that could have become the basis for real independent activity.
The name of the game is for the old organizations to secure control over oil resources using their position in the old system, then prepare for a new economic environment in which profitability of oil production will be very different and it will be possible to attract foreign capital.
Right now an uncontrolled dissolution process is going on in which bits and pieces of the state industry are being transformed into new forms of ownership. This is not an orderly denationalization process. The legal basis for such a development is not yet in place.
It could rather be termed quasiprivatization.
Apart from taking resources from the state without proper compensation, these developments contribute to a negative attitude toward legitimate privatization. It is important for foreign companies and Russian authorities alike to discriminate between projects that are simply exploiting the old structure and proposals that take open competition as their point of departure.
WHAT IS NEEDED?
As is the case in the market economies of the West, each actor, whether individual or organization, usually wishes to avoid competition for himself when he can.
One cannot expect an organization accustomed to a sheltered life to expose itself voluntarily to a competitive environment. This can be done only if authorities change the rules of the game.
From the outset foreign companies can be expected to show a similar attitude to competition. It is very tempting to enter into "special deals" with parts of the old structure. However, in today's circumstances such deals may be very vulnerable and short lives.
Realizing this, many larger foreign companies support creation of new laws regulating the oil industry. Naturally, they prefer rules favorable to foreign companies, but this is not their sole concern.
For foreign companies seeking long term engagements in Russia, legitimacy is the key. Only an economic and legal framework that can provide legitimacy can offer protection from political backlash.
As we see it, introduction of competitive procedures wherever possible is the vital factor in building legitimacy for foreign participation in the RusSian oil industry.
Competition is, of course, also essential if the Russian side is to derive maximum benefit from foreign participation.
CHEATING SOCIETY?
Accusations abound in the Russian press that foreign companies and their Russian partners cheat society. Deals are deemed unfair on the basis of information on profit or production sharing and similar features.
On the background of the rather obscure institutional landscape described above, it seems evident that many such accusations are warranted.
The problem is that similar charges can be made against almost any deal with a foreign company, even if the deal would appear well balanced from the point of view of an unbiased foreign observer,
The main reason perhaps is external as well as internal inconvertibility of the ruble that deprives any analysis of a standardized measuring scale.
CONCEPT OF RISK
Very important, too, is the lack of understanding on the Russian side of the cost factors a western company must take into consideration. Among them the risk concept is perhaps the most difficult to communicate adequately.
It must be realized there is no objective definition of what comprises a fair profit margin for oil companies. Economic conditions the companies demand will be determined by risk assessment as well as working conditions.
On the conceptual as well as practical level, Russians simply lack a risk concept.
It must be acknowledged that different projects have different risk profiles, and there is a price to pay for risk. The Russian side must realize its share of income generated from activities of foreign commercial companies will be influenced by risk assessments.
Consequently, it can improve its position by reducing the risk for companies.
Again, creation of a stable legal framework is conducive. But there are other factors. Development of infrastructure in a broad sense also will help reduce risks and thereby improve the position of the Russian side in negotiations with foreign companies.
As previously pointed out, demonopolization and competition are essential for achievement of efficiency. Without them, lifting price controls on energy could spell disaster.
In today's circumstances "free" oil prices would come to reflect not so much supply and demand as the monopolistic production and distribution structure.
Privatization does not, however, necessarily equal demonopolization if it is carried out along the lines seen until now, and state ownership does not necessarily mean ministerial regulation of all aspects of commercial activities.
Rules of the game are more important than ownerships.
STOCK COMPANIES
An important step would be to change the state organizations into joint stock companies.
This would mean that a differentiated structure of companies could emerge-companies in which the state has 100% ownership as well as companies with mixed ownership: state, private, and foreign. There also should be completely independent companies in which the state has no shares.
Whether the state takes part in exploitation of resources or not, it is in its interest to develop the resource base and see to it that development takes places in an efficient manner.
Consequently, the state requires competence in the field to secure its interests. This competence must be kept separate from commercial involvement in the industry.
There is little tradition for separation of the state's roles.
The control bodies that have existed so far, like Mining Control, have been very weak. The state now needs to create strong bodies that can control state owned and private enterprises alike.
Such bodies with strong professional independence will be a prerequisite for creating an efficient concession system that gives commercial actors certain rights to exploit resources in a given area. Independent bodies also will be essential to check compliance with environmental regulations.
Transformation of the Soviet oil industry into something new is far from complete. The coming months will be decisive for reforms that can bring about a new institutional basis that is a precondition for a turnaround in production.
Kryukov is senior researcher at the Institute of Economics and Industrial Engineering where he heads research into problems of economic development of the western Siberia oil and gas complex. Moe is senior researcher and director of Russian studies at the Fridtjof Nansen Institute.
Copyright 1992 Oil & Gas Journal. All Rights Reserved.
