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Peak Oil and Russian Power

iea041708.gifIt has become shorthand for journalists to describe Russia as “resurgent” and dramatically “more powerful” than it was in the year 2000. We generally accept this fact because of its impressive average economic growth of 6.4% over the past five years, swelling the GDP to $1.6 trillion. We also are led to this conclusion because of Russia’s increased foreign policy activism: how Moscow is working to build closer, independent relations with governments near and far, and wielding its UN Security Council veto with greater assertiveness to build a role of influence in global affairs. We see Russia’s muscle after natural gas cutoffs by Gazprom revealed their ability to choke Europe, and we’re reminded that this is the second largest oil producer in the world after every visit to the gas pump. Moscow has been very keen to project this image of power and renewed strength, but how much of a gap is there between economic and energy influence and hard military power? Judging by the recent incremental “tests” put against Russia’s policy preferences by the West (recognizing Kosovo, missile shield sites, and discussions of NATO enlargement), the Kremlin probably isn’t satisfied with the “respect” that it believes it deserves. Further complicating the metrics of Russia’s role as a new global power are the peak oil advocates, recently bolstered by comments made by Leonid Fedun, the vice-president of Lukoil, to the Financial Times. Russia, it seems, after years of increased state intervention in the oil sector, may be facing declining oil production – a frightening announcement which sent supply jitters across the trading floors and may cause some policymakers to reevaluate the dynamic of confrontation with Moscow.

According to the International Energy Agency, Russia produced on average 10 million barrels per day from January through March, marking a 1% decrease compared with 2007. Russia has not seen declining production since 1998. In an interview with the AP, one analyst pinned the country’s oil supply lull down to high taxes and insufficient reinvestment into infrastructure that could increase production from existing fields. “It’s not that we don’t have enough oil,” he said. “We just don’t have enough capital going into developing the fields.“Fedun points out that Western Siberia’s oil fields are running dry – just like Prudhoe Bay five or six years later, an effect seen from the Gulf of Mexico to Alaska. Capital investment is urgently needed for new fields in Eastern Siberia and infrastructure – but that’s exactly where the costs of Russia’s resource nationalism come home to roost.According to the Wall Street Journal, “Business investors have grown wary because the Kremlin has increasingly intervened in the energy sector. Russia nationalized former oil giant OAO Yukos and forced foreign investors like Royal Dutch Shell PLC to sell half its stake in a big project off Russia’s east coast to the state-run OAO Gazprom. TNK-BP has also come under pressure: Last month, intelligence services arrested one of its employees on suspicion of industrial espionage. TNK-BP said it is cooperating with authorities.” Even the recent $4.2 billion tax cut for the oil sector will probably not be enough, given that Fedun says the sector needs $1 trillion invested over the next 20 years to maintain current production levels.The last time Russia saw its oil production fall was during the 1990s, following the breakup of the Soviet Union. This trend was reversed as private energy firms, led my Mikhail Khodorkovsky’s Yukos, used advanced Western techniques to maximize oil production at stagnating existing fields rather than drilling new ones. The details of how Khodorkovsky and his team revolutionized the oil sector in Russia, creating the next decade of growth, was recently detailed in an excellent article by Michael J. Economides and Donna Marie D’Aleo.Fast-forward to the conclusion of the Yukos affair, and we see the transfer of some of the most valuable oil production assets into state hands (or, to be more precise, into the private pockets of some siloviki such as Igor Sechin, chairman of Rosneft). This new state management of the oil and gas sectors has been extremely damaging in terms of production, with a significant lack of investment in production and development of new fields. This is something that the IEA has repeatedly complained about, but it is easy to understand why state companies are reluctant to reinvest when there is such a low level of transparency, allowing for tunneling.Investment blogger Mike Burnick calls Russia’s oil production woes a “self-inflicted” wound. He argues that the Moscow energy mob has made it undesirable for energy companies to make new investments in production for the pattern of “renegotiated” royalty agreements, which reduce ownership stakes in production for international investors.Even beyond the harassment of the private energy sector by corruption entrepreneurs within the Kremlin, there is a fundamental problem when the state controls energy exports – decisions can often be made with political objectives in mind, rather than commercial, profit seeking behavior, which creates a distortion effect. This is explicitly stated in Rosneft’s prospectus for the 2006 IPO in London.Russia’s ability to hold up the image as a global energy superpower is of course strongly related to their ability to produce the stuff – and it does seem like energy strength has been its preferred method of advancing its foreign policy interests over actual military races. It is a wise strategic move. Russia’s military has been decimated following the Cold War, regarded by most experts as outdated, non-functional, chaotic and mismanaged. When Moscow recently decided to resume regular flyover missions by their Tu-95 Bears (which although old, can still carry nuclear weapons), the American reaction was comical. “They’re still flying those old things?” one State Dept. rep quipped.Like the Chinese, both Putin and his successor Dmitry Medvedev clearly understand that Russia’s interests abroad are best defended by bank accounts, rather than tanks and guns, which is actually a positive development. This was most clearly expressed by Medvedev himself during an early speech to the business community which he called upon Russian companies to buy as many Western companies and assets as possible.There is of course absolutely nothing wrong with Russia pursuing a foreign policy – and in many ways, to pursue political objectives via non-military avenues is indeed a relief for most citizens of the world. However the problem is that there seems to be a delay in this new power calculus in Washington and in the West (made even more complicated by the beginning of the end of Russian oil), resulting in these dangerous “tests” such as Kosovo, missile shields, and NATO enlargement. Eventually, Moscow will be forced to show its hand, and the West may be surprised by the cards they are holding.