Wednesday December 5, 2012, 11:10 am

The New York Times

December 4, 2012
Russian Oil Industry at a Crossroads as Infrastructure Ages
By THANE GUSTAFSON

MOSCOW — The Russian oil industry is at a crossroads. In the aftermath of the collapse of the Soviet Union, Russian oil output plummeted from an all-time high of 11.4 million barrels a day in 1987 to a low of 6 million barrels a day in 1996. But with the start of the new century, a stunning rebound began. And in the past few years, output has returned to a level close to its Soviet-era peak.

But there are signs of trouble. The industry’s traditional core, the giant West Siberian fields inherited from the Soviet Union, has been in decline since 2007. And while overall Russian production continues to inch upward (about 1.6 percent so far this year), that is thanks only to a strong burst of drilling in the older fields, plus the development of a handful of new fields at the periphery of the country.

Russia vies with Saudi Arabia as the world’s largest oil producer. But there is one crucial difference: Saudi Arabia has spare capacity and could increase output substantially. Russia, in contrast, is producing flat-out, close to the limit of its current capacity. Indeed, Russian oil production could well slip in the next few years.

This would be yet a new phase in the tumultuous history of Russian oil. The Russian government’s own experts have warned President Vladimir V. Putin that unless urgent measures are taken soon, production could sink as low as eight million barrels a day by 2020.

This matters for Russia and also for the world. For not only is Russia one of the two largest oil producers in the world, it is also one of the largest exporters, at nearly five million barrels a day. It accounts for 12 percent of world oil output.

At home, oil provides more than half of Russia’s export income and about 40 percent of the government’s budget revenue. But behind these numbers lies an inexorable fact: For the past twenty years Russia has largely been coasting on the oil fields inherited from the Soviet Union. Now the Soviet-era legacy is running down. Challenges lie ahead.

There is no such thing as “easy oil,” and the Russian oil industry works in some of the toughest environments on earth. But in the past thirty years the global oil industry has experienced a revolution in technology that has enabled it to find and produce oil in previously unreachable places.

The Russian oil industry, though it is now connected to global technology and has modernized extensively over the past twenty years, has participated only up to a point. In particular, it has not yet ventured into offshore Arctic fields or into unconventional sources like oil sands or shale.

The reason is straightforward: It has not needed to. But the next generation of Russian oil will have to come from places that are colder, deeper, more remote, geologically more complex and technologically far more demanding than anything Russian companies have tackled to date.

If it is to avert a decline, the country must follow the same path as the rest of the global industry. A series of major deals indicates that this is the direction Russia is beginning to go, but the turn has just begun.

Against this backdrop, the rise of Rosneft, Russia’s largest state-owned oil company, whose acquisition of TNK-BP is pending, is a highly significant event. When the deal is completed next year, Rosneft will become the largest publicly traded oil company in the world by output.

What does this mean for the future of Russian oil?

Remarkably, Rosneft’s present success, and indeed its very survival, are to some extent an accident. As late as 1998, Rosneft was a minor company, seemingly without a future. Its assets were the last remains of the Soviet Ministry of Oil, the second-rate bits that the emerging private companies did not want.

Privatization was the doctrine of the day in Moscow, and Russian leaders, in the era of Boris N. Yeltsin and the market changers then in power, did not want a state-owned oil company at all. In 1998, Rosneft’s low point, it was offered for sale by the Russian government, not once but three times, and if it was not privatized then, it was because no one wanted it.

The high point of privatization came in 2002, when the share of the private oil companies — integrated giants newly formed in the mid-1990s — reached 80 percent of total output.

With the election of Mr. Putin as president in 2000 the wind shifted back toward state control of strategic resources. Oil and natural gas were at the top of the list. In 2003 came the arrest of Mikhail Khodorkovsky and in 2004 and 2005 the break-up of Yukos.

Most of the pieces were captured by Rosneft, which tripled in size as a result. Suddenly, state oil was back. Today, the Russian energy sector is dominated by two large state-owned champions, Gazprom for natural gas, Rosneft for oil.

Between them, Gazprom and Rosneft have a virtual monopoly on all significant new oil and natural gas licenses, especially those in Russia’s Arctic offshore.

State ownership by itself is neither good nor bad. It depends on whether a company is run well or badly, and that in turn depends largely on its leadership and its relationship with the state. Which sort will Rosneft turn out to be?

In Igor I. Sechin, Rosneft has a chief executive of proven energy, who as Mr. Putin’s closest aide for two decades enjoys the president’s strong backing. As the de facto head of Rosneft since 2008, Mr. Sechin has already taken the company in major new directions. He has personally negotiated a series of new strategic agreements with ExxonMobil, Statoil, Eni, and now BP.

He has led Rosneft’s expansion into Venezuela and has overseen Rosneft’s successful drive into new territories inside Russia, in the far north of West Siberia and East Siberia.

At the core of Mr. Sechin’s vision for Rosneft is the Arctic offshore. Russia’s continental shelf extends across 11 time zones along Russia’s northern shoreline and is thought to contain vast reserves of both oil and natural gas. The actual size of the prize is still highly uncertain because less than 10 percent of the region has been explored.

But Russia — and Rosneft — have until now virtually no experience in working the Arctic offshore. They have not yet trained the people or mastered the necessary skills, and Russia’s considerable engineering industry, also largely inherited from Soviet times, is not yet prepared to produce the specialized equipment needed for Arctic offshore operations.

The challenge of moving to the Arctic offshore, as Mr. Sechin declared recently, “is more ambitious than man’s first walk in space or sending man to the moon.” And in his view and that of the Russian leadership, the ideal vehicle for such a venture is a large state-owned corporation like Rosneft.

But now, from a completely unexpected quarter, comes a new development. New production, coming from dozens of plays for what is known as tight oil — deposits accessible with new horizontal technologies — all across the North American continent, has suddenly made United States the fastest-growing oil producer in the world, with Canada close behind.

The tight oil story has been closely watched in Moscow, where Russian oilmen and politicians have quickly realized its enormous potential promise for themselves. At the time when Russia’s legacy fields are running down, tight oil — at least in theory — could lead to a renaissance. Some in the Russian oil community are even starting to say that Russia’s top oil priority now should not be the Arctic offshore but tight oil.

Yet tight oil, as the Russian proverb has it, “is not like just walking across a field.” Tight oil typically requires approaches carefully tailored to each oil field, an artful combination of technologies, much trial and error, and strict cost control. The “tight oil revolution” in the United States has been mostly the work of small and medium-size companies.

Consequently, it remains to be seen how quickly tight oil production can spread to the rest of the world. The question is especially acute in Russia, where independent companies account for barely 5 percent of total oil production, and state regulations frequently stand in the way of new techniques.

Thus the crossroads before Russian decision-makers is not simply a matter of moving to new regions and new technologies. The scale of the Arctic off-shore requires big companies. But having spent a decade rebuilding a large state-owned oil champion, Russian decision-makers must also focus on encouraging the widest possible variety of innovative companies and approaches. Diversity of approach will help Russia assure its oil future.

Thane Gustafson is a professor of government at Georgetown University and a senior director at IHS Cambridge Energy Research Associates. His latest book is “Wheel of Fortune: The Battle for Oil and Power in Russia.”

Thursday December 6, 2012, 5:00 pm
It would be good if alternative, renewable, affordable energies could be found worldwide.

Thursday December 6, 2012, 5:04 pm
So true greenplanet. You cannot currently send a star to greenplanet because you have done so within the last week.

Thursday December 6, 2012, 5:14 pm
maybe the time to find safer, cleaner, futuristic alternatives and encourage conservation, too....

Thursday December 6, 2012, 5:18 pm
Seems so Dave, You cannot currently send a star to Dave because you have done so within the last week.

Thursday December 6, 2012, 6:39 pm
This is one big disaster waiting to happen. The Russians are always reactive instead of proactive. What am I saying it's the same here.

Thursday December 6, 2012, 6:55 pm
That is indeed dangerous Michael. You cannot currently send a star to Michael because you have done so within the last week.

Tuesday December 11, 2012, 12:47 am
Green stars to Michael K and Greenplanet - sorry JLA and Dave C - the computer won't let me yet. The Russians have always lagged behind in terms of ecological protection - under the Soviets they managed to pollute Lake Baikal - the largest body of freshwater on the planet!

We have plenty of new technologies that can help us reduce our dependence on fossil fuels - wind, solar, tidal, wave, geothermal power - not to mention the research going on in labs in universities across the world - if only we had more COMMON SENSE than to irrevocably pollute and destroy the world which supports us - and is the only one we have!

Tuesday December 11, 2012, 7:41 am
Excellent historical and scientific context additions Pat! Unfortunately:You cannot currently send a star to Pat because you have done so within the last week.