Whither Russia?

DR. WILLIAM J. PIKE, Managing Consultant and Contractor, National Energy Technology Laboratory, and Chairman, World Oil Editorial Advisory Board

The coming year will likely be a crucial one for the Russian oil and gas industry. Most analysts believe, based on current operations, that Russian oil production will remain stagnant for the short-to-medium term. At rates of more than 10 million bopd, that might not be a bad thing for most countries. But internal demand in Russia is rising, resulting in less oil to export. For a country that derives 35% of its income from oil and gas (without which, the country would run a 10% budget deficit), the consequences of decreased export capacity could be serious. Solutions-—really good ones—are available. The problem is not a lack of potential but, rather, political uncertainty and uncertainty in the global market place.

Resources. Russian reserves are impressive. Take the Bazhenov oil shale in Western Siberia, for example. According to Sanford Bernstein’s lead oil analyst, Oswald Clint, the play covers 570 million acres, an area the size of Texas and the Gulf of Mexico, and 80 times bigger than the prolific Bakken play in the U.S. The Bazhenov pay zone averages over 100 ft thick and has been a source rock for Siberian fields in production for decades. A large pipeline and processing infrastructure is in place.

Then there is the large potential in the Russian Arctic. Here, the delayed development of the Shtokman field is illustrative of the problems plaguing oil and gas development in the country. A Shtokman development company, comprised of Gazprom, Total and Statoil, was established in 2008 to design and construct a field producing up to 410,000 boed. After the final investment decision was postponed a number of times, Statoil transferred its shares in the venture to Gazprom in July 2012. According to Russian President Vladimir Putin, “the investment decision is planned to be taken in the near future, so we are talking about a project launch before 2017.” Therein lays the problem.

Regulatory inconsistency. A two-fold process began in the early 2000’s. First, partly under the direction of Putin, private oil companies were invited in to further develop Russian potential. These companies, such as Yukos and Sibneft, brought in technology that increased production and profits. Then, mostly under Putin’s second term, these private companies were forced to relinquish some of these revitalized assets to state oil company Rosneft and state gas company Gazprom. The move was seen by many analysts as proof that Putin and company are intent on creating an all-encompassing energy holding company that will become an umbrella covering stakes in oil and gas producers, overseas oil and gas exploration and production company Zarubezhneft, oil pipeline company Transneft and other energy sources including electrical assets.

To accomplish this, Putin has appointed Igor Sechin, former deputy prime minister in charge of energy, as chief executive of Rosneft and chairman of Rosneftegaz which holds the country’s stake in Rosneft and 11% of Gazprom, In addition, Sechin has been named executive secretary of a Kremlin energy strategy commission that Putin chairs. According to Chris Weafer, chief strategist at Troika Dialog, a Russian investment bank, “Putin sees energy as the basis of Russia’s geopolitical bargaining power, and that has to stay under Kremlin control.” The questions thus become, can this structure accommodate much needed Western capital and technology in the form of new rounds of production sharing agreements/joint ventures with foreign companies and, as importantly, can this structure adjust to external market conditions?

Russia is actively working to address the first question. The government recently announced tax incentives to encourage production increases in Eastern Siberia and the far north. In addition, the country is creating a central clearing house for foreign access to the securities market, eliminating the need for access through a local broker. It is also amending tax laws to allow foreigners to access that market without paying exorbitant prices.

The government is also actively encouraging joint ventures with foreign firms. Exxon Mobil, Eni and Statoil have entered into ventures with Rosneft recently to develop Russia’s vast Arctic resources. And India’s ONGC expressed interest in a JV of the same nature in August after Moscow proposed the lifting of all export duties for new Arctic Shelf projects. Most interestingly, Putin, himself, has showed significant support of oil and gas development, going so far as to reverse his anti-fracing stand. Clearly, the country is in the game to increase oil and gas production through external participation. And it appears to be working.

But, there is the second question. While the Russian oil and gas industry may be able to manage market issues internally, the external marketplace will surely present problems. As noted earlier, Russian oil and gas exports are declining, due to increased domestic consumption. That will be compounded by the explosion of shale oil and gas development. Sustained development of these resources globally will further cut into Russian export potential while lowering prices for those products that are exported. This could be a serious stumbling block to full development of Russian oil and gas resources.