Russian Oil Supply: Performance and Prospects.

Russian Oil Supply: Performance and Prospects, by John d. Grace (Oxford: Oxford Institute for Energy Studies, 2005). 256 pages, cloth, $85; ISBN-10: 0-19-730030-8.

With crude-oil flows rivaling those of Saudi Arabia and crude-oil prices trading at levels well above $60.00 US per barrel

(WTI), the Russian Federation is, once again, poised to become one of the major players on global energy markets. At the same time conflicting reports from the Kremlin and Western media sources caution that the future direction that Russia's new role might assume is far from certain. In his book Russian Oil Supply: Performance and Prospects, James Grace gives us a unique perspective from which to view the complex and often confusing world of Russian foreign- and domestic-oil policy.

Perhaps the most important contribution of this book is an in depth analysis of Russia's physical-supply capacity. Grace provides the reader with an eloquent exposition of the evolution of the Russian crude-oil industry from its modest beginnings in Baku and the Apsheron Peninsula to Vladimir Putin, and the now infamous Khodorovsky affair. Foreign involvement, from the Nobel Brothers and the local refinement of crude oil to kerosene to the NEP of the Lenin years, is treated in careful, and colorful detail.

Whether cause or effect, the rise and fall of Russian crude-oil flows often followed that of its leaders. The demise of the Romanov dynasty was accompanied by the signs of depletion of Russia's two largest supergiant oil fields. Discoveries in Kazakhstan, Turkmenistan, the Caucasus, and eventually Western Siberia foreshadowed the unprecedented successes of the Soviet Union. The collapse of production from the largest Siberian oil field--Samatlor--accompanied the collapse of the Soviet Union. Perhaps not surprisingly, the year 1988 marked the last year of peak production from the USSR and the final year of the Soviet government itself.

Grace highlights the key role of the Russian Federation's first independent government, the Yeltsin administration, in the determination of current and future crude-oil flows. While the regime itself did not survive, it was successful in liberating the Russian crude-oil industry from a complete dependence on state budgets and five-year planning targets to a slightly more competitive industry that would be forced to rely on crude-oil supplies to domestic and foreign markets. "It is this institutional innovation that will play the largest role in determining future supplies and the least likely to be reversed." [p. 3]

The concise summary of the peak, collapse, and recuperation of the Russian oil supplies is followed by a detailed and informed analysis of the organization and performance of the contemporary crude-oil industry. Specifically, Grace uses the chapter on industry performance to follow the complex maze of regulation and deregulation that has accompanied the transition from a command economy to 'free enterprise'.

"The passage of the Russian oil industry to its present structure has been, as Winston Churchill once famously said of Russia itself, a 'riddle wrapped in a mystery inside an enigma.' The route was torturously complex and many of the details are still unknown outside a small circle." [p. 105]

Needless to say, all of the Russian upstream petroleum companies can trace their beginnings to the legendary Soviet Ministry of Oil. Reminders of this institution can still be found in all existing organizations. By 1995, all of the Soviet-era production associations had been transformed in one way or another. While 20 remained in state hands, 13 had been listed as private companies or their subsidiaries. Notable among these are Lukoil, Yukos, Surgutneftegaz, Slavneft, Sidanco, Komineft, Eastern Oil, and Onako.

Less than ten years later, by 2004, the list of major players in the Russian upstream petroleum industry had been reduced significantly. Indeed, in the opinion of Grace, only five major players remain today--Lukoil, Yukos, Sibneft, Surgutneftegaz, and TNK-BP. These five, a number of independents, the regional majors such as Tatneft and Bashneft, and a small number of Joint Ventures and Production Sharing Agreements (PSA's) were responsible for the bulk of Russian crude oil supplies in 2003--over 7 MMB/d. The remainder, some 600,000 b/d can be attributed to the state oil concerns, Gazprom and Rosneft. The reserves and prospects for these companies are listed in detail in Chapter 5.

The dissolution of the USSR and creation of a number of major oil companies is one of the major forces preventing the teleological evolution of Russian crude-oil supplies. Indeed, in Grace's words, "Barriers to entry for independent oil companies are a big reason why there is still, twelve years after Russian independence, a vast Soviet dowry of discovered, but undeveloped fields. Most of the Russian majors (with the exception of Surgutneftagaz) are over-endowed with physical oil assets relative to management capabilities and even to their greatly expanded access to cash. That is, they stand astride far more fields and physical oil than they have capital and management resources to develop. Without a second tier of companies to buy these assets from them they will languish." [p. 162.]

Despite these difficulties, the forecast for crude-oil supplies is cautiously optimistic. As of 2004, the Russian crude-oil industry had been successful in its attempts to rejuvenate the industry, and production had been rising steadily for the past 6 years. With only slight disruption, these trends have continued to today. Contemporary estimates place Russian crude--oil reserves at levels as high as 68.2 billon barrels (proved) and 80 billion barrels of undiscovered resources. With new-field production from promising new-field developments such as the Lukoil- Timan-Pechora project, Sakhalin I, and the Shell-Sibir energy project, Russian crude-oil flows could easily be sustained at levels as high as 9-10 MMb/d through the year 2010. An increase of over 10 MMb/d, might be reached, given favorable political and economic conditions, but is unlikely to be sustained. In short, a rate of production over the 10 MMb/d mark is likely to be followed by an increase in future decline rates, reminiscent in some respects of the rapid decline rates witnessed by the Soviet Union in the late 1980's.

To stem the potential for premature and rapid decline, Grace suggests that a more sustainable course might be charted for the development of the Russian upstream petroleum industry. Specifically:

1. Setting taxes and policies on export and licensing to guide output between 9 and 10 MMb/d through 2010.

2. Developing a stable technological foundation for production.

3. Encouraging the entrance of small- and medium-sized oil companies to develop hundreds of discovered but undeveloped small- and medium-size oil fields.

4. The removal of price controls and movement towards a world parity price.

5. Trading environmental liabilities (oil-related environmental disaster) originated in the Soviet era and now falling on the shoulders of private companies--back to the state.

While the future direction of Russian energy policy is by no means certain, the encouragement of small- and medium-size oil companies will require much more than a favorable climate for foreign direct investment. World-oil prices in the $50-$60 US per barrel range provide clear economic incentives for even the most recalcitrant of market entrants. Still, the economic and political incentives are unclear. Unlike major oil companies, who have sufficient resources to weather temporary storms, the long-term success of smaller independents is threatened by the existence of a tough, revenue-based domestic- and foreign-tax regime. Such firms cannot survive without legislative assistance, and the creation of stable petroleum legislation and an independent judiciary remains a far and distant goal.

In the words of Grace, "[This] Lack of clarity may have been intentional. If 'majority-Russian' and 'strategic assets' are left vague, the policy becomes even more potent in defining narrow spaces in which foreign investment will be allowed. As an independent judiciary is still absent, interpretation can be individualized, giving high-level appointees authority to pass on proposals, based on either national or much narrower interests." [p. 232.]

Jennifer I. Considine

University of Dundee