BAKER INSTITUTE STUDY

PUBLISHED BY THE JAMES A. BAKER III INSTITUTE FOR PUBLIC POLICY AT RICE UNIVERSITY

NO.21 FEBRUARY 2003

U.S.–RUSSIA COMMERCIAL ENERGY SUMMIT

In May 2002, U.S. president George W. Bush and Among those who spoke on the importance of Russian president Vladimir Putin announced a the new partnership were Russian energy minis- new U.S.–Russian dialogue. This “dialogue” rep- ter Igor Yusufov, Russian economic and trade resents an unprecedented political alliance, minister German Gref, U.S. commerce secretary friendship, and economic partnership between Donald Evans, and U.S. energy secretary the U.S. and Russia at the highest levels of gov- Spencer Abraham. The summit was organized by ernment, creating opportunities for strengthen- the U.S. and Russian governments, the U.S. ing ties and developing many spheres of cooper- Energy Association, the American Petroleum ation. Among the many important strategic Institute, American Chamber of Commerce in areas for potential cooperation between the U.S. Russia, U.S.–Russia Business Council, the City of and Russia is the energy sector. Houston, and the Baker Institute. In a follow-up to the May 2002 announce- In recent years, both the U.S. and Russia have ment, Washington and Moscow convened the been seeking to enhance their national energy U.S.–Russia Commercial Energy Summit on agendas and recently have found that their October 1–2, 2002, in Houston, Texas. The main interests are dovetailing, raising the importance plenary sessions for the meeting were held at the of the Energy Summit. James A. Baker III Institute for Public Policy. Top officials from both nations emphasized The meeting was aimed at the development of the strategic importance of this cooperation Russian/American joint strategies for coopera- throughout the session. Presidents Bush and tion in the energy sector. This inaugural summit Putin, during a meeting they held in St. brought together senior government officials Petersburg on November 22, 2002, also made a and corporate executives representing more point to highlight the first Commercial Energy than 70 American and Russian energy compa- Summit as a key step in the energy dialogue nies. The session led to the creation of a com- launched by the leaders earlier in the year. In a mercial working group to focus on key issues joint statement, the presidents said, “The such as market development, strategic reserves, Houston Summit created new avenues for dia- investment, regulations, education, and prob- logue and cooperation on energy issues and led lem solving. to decisions on concrete new investment proj- The summit laid out a framework and road ects and programs and business arrangements.” map for the cooperative effort between In the keynote address that closed the sum- American and Russian firms in the energy sector. mit, James A. Baker, III, former U.S. secretary of

1 state and honorary chair of the Baker Institute, development—a growth rate he expected would discussed the mutual benefits of closer be matched in 2002. The Russian minister pre- American–Russian cooperation in developing dicted that Russian oil production would expand Russia’s energy assets. Baker explained, “The to 8 million barrels per day (b/d) within the commercial advantages to cooperation between next few years, based on new investment and the U.S. and Russian energy companies is really new technologies. quite obvious, but the commercial stakes—even Russia and the newly independent states of its though they are huge—are only part of the southern flank are ranked second in undiscov- broader economic advantages that will flow from ered oil potential after the Persian Gulf, holding closer U.S.–Russian cooperation in the energy about 27 percent of the world’s total. The region area.” ranks first globally in undiscovered natural gas Continuing, Baker noted that “the early and potential and will be an important supplier of oil efficient development of Russia’s oil and gas and gas to Europe and Asia. Russia itself resources also will represent a substantial eco- accounts for 13 percent of the world’s energy nomic boon to Russia in terms of jobs, generat- production, third after Saudi Arabia and the ing economic growth and bolstering Russia’s U.S. In 10 years, the Caspian Basin countries balance of payments. And, of course, to the near Russia could represent an additional 3 to 4 extent that American companies are involved, it percent of world oil production, while Russia will benefit American businesses and consumers itself is hoping to see its crude output rise from through lower and steadier petroleum prices. over 7 million b/d in 2001 to over 10 million But, not least and perhaps most important of all, b/d by the end of the decade. the full development of Russia’s immense poten- Russia’s hydrocarbon supplies are badly need- tial by increasing diversity of international sup- ed by the expanding world economy, whose oil ply will reduce considerably the risk of instabili- and gas requirements will continue to grow sig- ty in a world petroleum market that remains nificantly in the coming decades. An improve- dominated by the volatile Middle East.” ment in the Russian oil and natural gas industry The Bush administration has been champi- is in the interest of not only the U.S., but also oning the importance of developing more other significant players such as the European diverse energy supplies as a means of both Union (EU), Japan, South Korea, and China, national and global energy security especially in since it would add to world supply and thereby light of the new geopolitics created in the after- lower energy costs. math of the September 11, 2001, attacks on the U.S. officials stressed the importance of U.S. The U.S. administration would like to pre- Russian energy supplies to the global economy. vent future oil price shocks and lessen depend- “All of this [cooperation] enhances global ener- ence on supplies from the unpredictable Middle gy diversity and global energy security goals that East. both of our countries share,” said U.S. com- In stressing Russia’s potential as a leading merce secretary Donald Evans in his opening global oil and gas supplier, Russian energy min- remarks to the summit. Evans emphasized, ister Igor Yusufov, in his keynote address, noted “Global energy security is one of the greatest that his country currently controls about one- challenges we face today.… It is recognized as third of the world’s gas reserves and that in 2001, one of the most important priorities of Russia experienced a 7 percent increase in oil President [Bush’s] national energy plan.”

2 Commerce secretary Evans stressed that both in Congress. The plan, developed by Vice the U.S. and Russia play a pivotal role in global President Dick Cheney’s cabinet-level task force, energy markets. The U.S., for one, he said, “is calls for less U.S. reliance on Middle East energy the largest producer and consumer in the world supplies by cultivating domestic production and and is also the world’s largest net importer of alternative sources and strengthening ties with energy.” As for Russia, it has the advantage of allies that are producers, including Canada, being well positioned because, “as well as being Mexico, and Russia. the third largest [energy] consumer in the Russia clearly sees further development of its world, it is also one of the world’s largest crude oil and natural gas sectors as an important exporters, second to Saudi Arabia,” Evans said. element of its future economic growth. Russian He pointed out that Russia is not only blessed energy minister Yusufov echoed his American with the largest natural gas reserves in the world, counterpart’s observation that there was a great but it also is the global leader in gas exports. deal of similarity in the two nations’ energy Noting that the U.S. Commerce Department has plans. “They even complement each other recognized Russia as now having a market-based because we do have some undeveloped economy, Evans said, “Its market economy is an resources in the Russian Federation that can important step leading to expanded trade and become very reliable sources of energy supplies investment for Russia.” for the United States,” Yusufov explained. Washington looks to Russia now as a poten- Turning to the importance of American tially reliable supplier of crude to the U.S. mar- investment in his country’s energy sector, the ket, not only helping it with energy security by minister noted, “The operating of our existing diversifying American imports and satisfying its fields and operating fields with difficult own growing demand, but also being mindful resources [to recover] will require major innova- that larger volumes of Russian crude and gas tion in the industry, which in turn will require entering into the global energy market will help major investments. Here is an opportunity to lead to international price stability. involve advanced technology, which is being U.S. energy secretary Spencer Abraham elab- developed in the United States…. The major orated on this point, observing that “the chal- success in providing political stability in the lenges of energy security and environmentally Russian Federation makes it a reliable partner to responsible economic development enter into the U.S.” every calculation of every nation.” Stressing that However, the opportunity to participate more there are similarities in the approach between proactively in Russia’s oil and gas industry is not U.S. and Russian national energy plans, without many challenges. U.S. private sector Abraham said, “We’re both on the verge of work- attempts to become involved in Russia’s energy ing toward completion of energy legislation.” In sector during the 1990s had mixed results. terms of the American national legislation, the Experts say Russia needs to overhaul its legisla- U.S. energy secretary stated, “We emphasized in tive and tax system if it is to attract ample private our plan the need to diversify our energy sup- Western investment in both existing Russian oil plies, develop more trading partnerships, and and gas producing areas as well as in the more expand opportunities for imports.” technically challenging and economically risky The U.S. national energy plan, as advocated frontier areas. For Russia to increase its global by the Bush administration, is pending approval role as a leading crude and gas supplier and tap

3 into the U.S. market as well as other emerging fied, as 90 percent of Russia’s gas production is markets, American and Russian energy firms controlled by state giant Gazprom. In 2001, total must also concentrate on expanding the coun- gas output was 595 billion cubic meters (BCM) try’s export infrastructure, which has, to date, with a forecasted 3 percent increase in 2002. The limited Russia’s ability to move beyond its status Russian energy minister stated that his country’s as a regional exporter to Europe. gas export capacity could be raised by 40 percent In the summit’s initial meeting, the dialogue by bringing a new gas pipeline into operation. identified problem areas that are blocking the Looking at international and domestic full potential for commercial cooperation and demand forecasts, Yusufov suggested, “There is a investment in Russia’s energy resources. possibility that by the year 2010, Russia will pro- Discussion focused on the two governments’ duce approximately 650 BCM/Y; according to roles in solving legislative impediments. the Strategic Gas Plan for the year 2020, this vol- Identifying policy frameworks to remove these ume could reach 700 BCM/Y.” He added that obstacles will be a challenge facing both coun- Russia is looking to the Yamal area in the north- tries and their private sectors in the coming ern region for further gas exploration. The years, particularly in Russia where there are both Russian energy minister noted that more than advocates and opponents to overhauling the half of Russia’s undeveloped energy resources contractual agreements and tax systems that lie in the remote areas of the Russian have bedeviled foreign investment in the coun- Federation, some of them above the Polar try’s energy sector to date. Circle. If concrete plans of the Russian oil firms and Russian officials addressing the conference their Central Asian counterparts come to made clear that Moscow intended to diversify fruition in the coming years, rising oil exports the destinations for its oil and gas exports. This from the former Soviet Union (FSU) could grow geographical expansion of Russia’s energy by 2 million b/d in the next five years and move exports is of particular importance to Moscow closer to rivaling those of Saudi Arabia. for another more economic reason: Russia’s pri- Traditionally, Russian oil exports have been mary market for oil and gas is Western Europe, bound for Europe and have not competed with which is expected to see limited increases in its Middle East oil exports to the U.S. and Asia, but demand in the coming decades, prompting pro- this trend is changing. Persian Gulf suppliers ducers to look elsewhere for new opportunities. have warned that growing Russian exports could Compared to the anticipated U.S. growth in lead to a price war, particularly if markets cannot crude imports—from 9.3 million b/d in 2001 to easily absorb the extra volumes. 12.3 million b/d in 2010—Europe will see a Russia’s energy industry is increasingly priva- much slower growth in imports, from 9.3 million tized, leaving the fate of future production in b/d in 2001 to just 9.6 million b/d by the end of the hands of private companies. While oil pro- this decade, Tyumen Oil Co. president Simon duction in Russia involves more than 200 com- Kukes told the summit participants. panies, approximately 90 percent of Russian oil Kukes explained the marginal increase in is being produced by 10 vertically integrated European imports is due to “the taxation system multinational firms, the Russian energy minister in Europe, which will not allow people to con- said. Minister Yusufov explained that the picture sume more gasoline.” In addition, he noted that for Russian natural gas production is less diversi- it is in Russia’s interest to pursue new markets, as

4 rising output from Kazakhstan and Azerbaijan ports. The Tyumen president mentioned that will compete with Russian crude in its main there were several pipeline projects under inves- European market. tigation: a China route, one to Far East Russia, Energy contributes an important and devel- and a third, which is in early stages, to the north oping link between Russia and Europe. Russia for export from a deepwater port to be con- currently exports between 2 and 2.5 million b/d structed at Murmansk. He contended that of oil and an annual 136 BCM of natural gas to within several years, if these latter pipeline Europe, including the Ukraine, meeting about options are pursued, exports to the U.S. could 20 percent of Europe’s gas needs and 16 percent be bumped up by as much as 600,000 to of its oil supplies. In October 2000, President 650,000 b/d. Putin signed a strategic energy partnership with Beyond the U.S. market, China could become the EU that will allow natural gas exports to another important outlet for rising exports of Europe to rise to 200 BCM by 2008. Russia is one Russian oil and gas. Beijing sees Russia as a key of Europe’s cheapest suppliers, given the rela- future hydrocarbon supplier with the further tively low cost of transportation, so economic development of Sakhalin resources, and there motivations are clearly central for both Europe has been a recent political push both in Moscow and Russia for this energy trade. and Beijing to facilitate growing cooperation Kukes pointed out that Russian firms must be between Russian and Chinese firms in oil and willing to take financial losses in the short term gas investments and trade. A similar warming of as export routes are being studied if they want to relations on energy trade issues has taken place gain a foothold in the U.S. market. He reflected between Moscow and Japan. The oil and gas that it costs about 45 cents a barrel more for resources of the Sakhalin Islands are expected to Russian crude to be shipped to the U.S. from the be a major energy supply for Japan and China Mediterranean, but “when you need to explore and a key means for both Tokyo and Beijing to new markets, sometimes you must bite the bullet diversify from dependence on the Persian Gulf. for the first couple of years and take some loss.” One pipeline project under examination is a He said his company was continuing to explore $1.7-billion Yukos/PetroChina line from export routes to the U.S. and noted that a Angarsk in Northeastern Russia to Daqing in 120,000-tonne cargo of Russian crude was sold in Northeastern China, which could pump as much September 2002 to U.S. refiner Koch, with part as 600,000 b/d of Russian crude to the Asian of it dedicated to the U.S. Strategic Petroleum giant within about five years. Reserve. The Russian oil industry is at a crossroads in Kukes noted that there were several ways that its national energy plan, with legislation cover- Russian crude marketing could be improved, ing amendments to the production sharing including encouraging long-term Western agreement (PSA) law stalled in the state Duma, investment in the Russian oil fields. He suggest- which has been notoriously slow in moving on ed that a U.S. firm like ConocoPhillips, for sensitive issues. Although a framework for PSAs example, could come in and produce oil, subse- was laid out in a presidential decree in 1993 and quently developing a mechanism to supply this subsequently passed into law in December 1995, oil to its own refineries in the U.S. detractors say the present law contains many Another method for marketing improvement inconsistencies that hinder effective enforce- is to develop new pipeline routes and deep-sea ment.

5 Western investors are keen to see the amend- than delicate ecological systems. We had to live ments enacted as a means of ensuring that the with tariffs that changed almost on a daily basis, overall level of taxes remain stable during the tax laws that seemed to change every month, and entire period of the individual PSA’s validity. regulations and export volume allocations, all This would insulate the investor from frequent subject to sudden and unpredictable change.” and unpredictable tax changes that have typified Russian economic trade and development the foreign investment climate in Russia over the minister German Gref appeared to endorse past decade. Dunham’s view on PSAs, noting in his opening The issue of amending the existing PSA legis- address to the summit attendees that “we have to lation is clearly one that not only pits American depart from the administrative system that is investors against Russian energy firms and presently in existence. Investors have to be able bureaucrats who benefit from maintaining the to get maximum guarantees in order to be will- status quo, but Russian firms against each other. ing and ready to provide substantial investments In addressing the summit, ConocoPhillips chair- in prospecting, opening up those deposits, and man Archie Dunham acknowledged that Russia building infrastructure.” had enacted its PSA law in the mid-1990s, but Furthermore, he said that “the growth rate in “for the PSA model to work in Russia, Russia’s the [Russian] oil output will be dependent on tax laws and other regulations need to be the economic and market situation, and on how brought into harmony with the new law on well we will be able to implement the legal rights PSAs…. The fact remains that until all of the of the investors.” Russian state firm Rosneft vice components of the legal framework are in place president Alexey Kuznetsov concurred on the in Russia, PSAs [in their current form] will not need for effective PSAs, telling summit attendees provide the stability and security that are the that “the PSA legislation is necessary in Russia, whole reason for using this type of fiscal frame- and so far, it seems to be the only arrangement work in the first place.” that can provide safety and security to investors.” Dunham cited the specific example of the He continued, saying, “In my opinion, provided Polar Lights project that partnered Conoco we develop certain mechanisms, our countries in a joint venture with Russian firms can become the international guarantors of Arkhangelskgeoldobycha and Rosneft. The proj- energy security… so I believe that new [Russian] ect—the first Russian–American joint venture to regulatory regimes are inevitable.” develop a new oil field in Russia—began pro- However, there is clear opposition by some duction in 1994 from the harsh Arctic tundra of major Russian energy firms to the idea of adopt- the Nenets Autonomous Okrug in the Timan- ing PSAs as the legislative model for Western Pechora Basin and recently passed a production firms looking to invest in oil and gas projects in milestone of 75 million barrels from the Ardalin Russia. Presenting the contrary approach at the field. summit, Yukos Oil Co. chairman and CEO But, according to Dunham, the project, which Mikhail Khodorkovsky cited several reasons why was not covered under a PSA agreement, has Western investors are mistaken in pursuing a been only “marginally profitable.” He noted, revised PSA framework as their only option for “We successfully completed Polar Lights, but we working in the country. had to contend with more than harsh weather Khodorkovsky explained that many American conditions and we had to step through more companies have missed market opportunities

6 and experienced increased competition because er U.S.–Russian cooperation has meant “Russian they insisted on waiting for PSA legislation. He firms have started to assign higher priorities to noted that the 4-billion-barrel Priobskoye devel- projects that are geared toward the American opment project in the Northern Territories in market, provided there is a flow of private invest- Siberia that had partnered Yukos with then U.S. ment of American capital.” Alekperov pointed firm Amoco was delayed indefinitely due to out that while oil extraction from the North Sea, intransigence from the U.S. side. According to the Gulf of Mexico, and Canada will decline and Khodorkovsky, “for five to seven years, [Amoco] future development in those areas will tend continued to negotiate in hopes that the PSA toward costly, high-risk deepwater exploitation, regime would be put into effect. If, in 1998, the the Russian oil industry is on the rise. companies had started to work on the Russian firms have been able to marshal capi- Priobskoye field under the national tax regime, tal on their own to revive the Russian oil indus- today in 2002, it would already be getting pure try. According to Alekperov, “it is expected that net profits.” Instead, BP, which took over by the year 2010, Russia’s oil production will Amoco, pulled out of the project in March 1999. reach 10 to 12 million b/d.” He stated that The Yukos leader also criticized PSAs for Russia’s oil deposits, audited by international bringing “a quantum increase in corruption.” rules, amount to around 76 billion barrels, He explained, “Everybody knows how to count which he said was about 60 percent higher than numbers, and the advantages that PSA partici- the commonly accepted estimates. However, pants get are valued by those who make the “through the expansion of fields in the North decisions—government officials and the state Caspian, Sakhalin, and the North Arctic Sea, Duma—and if American firms don’t pay bribes indications are that the total deposits of oil are directly, it means that the Russian partners are probably 140 billion barrels,” Alekperov said. paying the bribes.” Finally, said Khodorkovsky, While Russian output and production from the insistence on PSAs by U.S. investors leads to FSU countries like Kazakhstan are expected to a neutralization of efforts to stabilize the tax boom in the coming years, the problem will be regime. However, existing PSAs, he stressed, “in in export capacity. “This can be a threatening all cases should be retained. What has already factor, so it is important to implement pipeline been signed needs to stay in effect.” projects soon,” the LUKOIL official said. He The Yukos CEO pointed out several other noted that the Caspian Pipeline and the Baltic areas in which he felt U.S. investors were miscal- Pipeline networks are being expanded and his culating when eyeing Russian opportunities, company is building out its own infrastructure including their reluctance to utilize Russian- in Russia. made equipment in the field and their general The 284-mile Baltic Pipeline System (BPS) overestimation of Russia’s investment risk. involves the laying of a new main pipeline from “When we see Russia at 70th, 80th, sometimes Kharyaga in the Arkhangelsk region to Usa even 120th place in the ratings of investment in the Komi Republic, the reconstruction attractiveness, we understand that Western of the Usa–Ukhta, Ukhta–Yaroslavl, and investors are deluding themselves. Russia is a Yaroslavl–Kirishi pipeline segments, the con- quite stable place,” Khodorkovsky said. struction of a new pipeline from Kirishi to For his part, LUKOIL president Vagit Primorsk, and an oil refinery in Primorsk on Alekperov told the summit participants that clos- the Gulf of Finland.

7 The first stage of the BPS, with an export would replace current makeshift operations capacity of 240,000 b/d, became operational in where Russian companies such as Yukos have December 2001. The BPS, which will export been loading transatlantic VLCCs in the most of the oil from the Timan-Pechora and Mediterranean to sell in the U.S. The oil is cur- West Siberian oil provinces as well as some oil rently brought to the Mediterranean by smaller from Kazakhstan, gives Russia a direct outlet to vessels shuttling from the Black Sea. The northern European markets, allowing the coun- Murmansk route across the ice-bound Arctic to try to reduce its dependence on transit routes the U.S. would be considerably shorter than the through Estonia, Latvia, and Lithuania. Use of distance from the Persian Gulf to the U.S. the BPS, which is fully owned and operated by A feasibility study of the port project, which is Transneft, should bring the Russian government slated to handle up to 1 million b/d of exports $100 million per year in fees, as well as allow and involves building both the port and a 935- Russia to save up to $1.5 billion each year in mile pipeline leading to it, is being financed by transit tariffs. Further development of the BPS is four of Russia’s biggest energy firms, LUKOIL, to be conducted by Rosneft and Surgutneftegas, Yukos, Sibneft, and Tyumen. The project, which with the goal of bringing in U.S. firms. could be completed by 2005 at the earliest, is to As Russian export infrastructure expands, receive U.S. Ex-Im Bank support. Russian oil firms are expected to be able to sup- ChevronTexaco vice chairman of upstream ply at least 13 percent of U.S. oil imports, up Peter Robertson was upbeat about the ability of from the less than 1 percent currently supplied Russian companies to both resurrect their ener- now. However, the further development of gy sector and expand upon it. Said Robertson, pipelines in the Caspian and Baltic Seas will still “In the past decade, we’ve seen the kind of not compensate for export capacity shortage. explosive growth that marked the start of the According to Alekperov, restrictions in the Russian oil industry…. What we’re seeing is Bosphorus and Danish Straits make it impossible nothing less than a renaissance in Russian oil.” for Russian oil to be delivered by major tankers. And the future is even brighter, he contended. “In order to reach American markets, we “We know that few countries can match Russia’s need a transportation route that has fewer reserves and no country can match Russia’s investment risks and could maintain competitive unique position standing astride two conti- transportation rates. We need to build a pipeline nents,” Robertson said. from Yaroslavl [in Central Russia] to Noting that the recent impressive growth in Murmansk,” the LUKOIL head said, pointing Russian energy output has been largely based on out that the Murmansk terminal “is not freezing turning around production from Western the year round, and it can receive oil tankers Siberia, the ChevronTexaco official claimed that with dead weight of 300,000 tonnes,” unlike the “the next big step for Russian oil and gas devel- rest of Russia’s ports, which are mostly in shallow opment is clearly going to be in the frontier waters. areas, including Sakhalin and the Arctic Shelf.” The proposed $1.5-billion project to build a There exists a substantial amount of potential pipeline and deepwater, year-round port at for developing further West Siberian output, Murmansk, in the north of Russia, could be used which Robertson asserted would continue to to export oil in very large crude carriers (VLCC) bring in a steady flow of cash for years to come. to distant markets such as the U.S. The port A case for that development under the existing

8 tax and license regime could be made, given that China hopes to be a primary beneficiary of infrastructure already exists, reserves are accessi- the supplies from new investments by Western ble, and revenue can be generated relatively firms at Sakhalin and from other new field devel- quickly. opments within Russia. Sakhalin is seeing robust However, in the frontier areas—such as progress, with ExxonMobil having finalized its Sakhalin and the Arctic Shelf—everything is dif- multibillion-dollar investment project in late ferent because of the complexity of the work, the 2001. Initial oil output of 160,000 b/d by 2003 is high risk, and the high cost, the ChevronTexaco expected to grow rapidly to 250,000 b/d from vice chairman noted. “Huge commitments must the Chavyo field alone. A related natural gas be made up front before there is any meaningful pipeline plan involves some 9.5 BCM/Y of revenue…. To introduce such an investment exports to Japan and potentially Korea and requires clear terms and conditions, a commit- China. ment that a fiscal regime in place during an Royal Dutch/Shell Group also has a major investment phase remains in place during the project slated to come on line in Sakhalin II that revenue stage and that some costs can be recov- will expand oil production from the current ered with confidence,” Robertson said. He sug- 15,000 b/d to 120,000 b/d by 2006. The Shell gested that PSA legislation, while having a limit- plans involve the construction of the largest liq- ed application over the next few years, could uefied natural gas (LNG) plant in the world, at provide the necessary stimulus for opening up 9.6 million tonnes per year, to be built at the challenging frontier areas to exploration. Prigorodnoye in south Sakhalin, which is to be One such prospect, he said, is the Kirinski the first LNG plant built in Russia. So far, the block in Sakhalin III, where ChevronTexaco has Shell consortium’s exports have been dedicated a 33 percent interest in partnership with Rosneft to China, Japan, Korea, and the U.S. Within the and ExxonMobil. According to Robertson, next four to five years, Russian supplies to East below those 150 meters of water lie an estimated Asia from Sakhalin fields under current devel- 500 million tonnes of oil and gas equivalent. opment are likely to provide upwards of 500,000 “Looking beyond the PSAs, I am encouraged by b/d of incremental supply. the moves to reform the Law on the Subsoil. If Moreover, new areas are now under discus- that legislation can be developed successfully, it sion for development by Western and Russian will be a natural successor to PSA and will even- firms, including BP and Rosneft’s joint operat- tually make PSA-type contracts redundant. ing company, which will explore for oil and gas However, in the near term, PSAs are necessary,” in the Sakhalin IV and V blocks starting in 2004. Robertson said. There is an estimated 3.53 trillion cubic feet ChevronTexaco stated in early October 2002 (TCF) of gas in the Astrakhanovsky block in that the company was considering investing up Sakhalin IV, which will require some $2.6 billion to $9 billion in Sakhalin II if estimated reserves to develop, while the East Schmidtovsky blocks prove satisfactory. U.S. energy secretary hold an estimated 4.4 billion barrels of oil and Abraham noted that the projected outlay by 21 TCF of gas. A strategic investor is also being U.S., Russian, Japanese, and Indian firms in the sought for the Sakhalin 6 zone held currently by multiple Sakhalin phases of as much as $15 bil- Alfa Eco. lion makes this project the largest investment in Beyond Sakhalin, there are other prospects in Russia. Eastern Siberia, where Yukos, the Russian firm

9 holding perhaps the largest potential reserves Russian crude that could be used to serve coun- in the area, is already in discussion with tries that aren’t currently able to amass strategic CNPC/Sinopec on joint projects. Yukos holds stocks, providing for more oil market stability in what it claims are 11 billion barrels in the times of crisis. The Russian stockpile would be Yurubcheno-Takhomskaya zone in Eastern used to supply markets during times of market Siberia in the region of Krasnoyarsk. It has a emergency and to dampen price run-ups. development plan to spend $1.7 billion on 2,300 Tyumen president Kukes, in fact, addressed miles of pipeline to bring oil to the market. this subject at the summit, calling for the cre- Yukos and Russian pipeline company Transneft ation of a U.S.–Russian Strategic Energy Reserve are vying for the pipeline rights, and it may be for third-world countries, notably in Asia. “The that two lines, rather than a single one, will be idea is that the U.S. and Russia would create a built. strategic partnership in which Russia would sup- ConocoPhillips chairman Archie Dunham ply crude and the U.S. would provide some form noted that one area of great interest to his com- of financing, and third-world countries who are pany is in the Timan-Pechora region in the willing to hold these strategic reserves would pay Barents Sea, where the U.S. firm has been work- for storage and call options, unless they use the ing with LUKOIL and Gazprom. Stressing that crude,” Kukes explained. Of course, if these fields in the Northern Territories are believed to countries tap into the reserves they are holding, have reserves in excess of 1 billion barrels of then they would repay the banks, he added. crude and 1 TCF of gas, Dunham said that “esti- Kukes pointed out that there are several existing mates indicate that these resources could direct- storage bases that would benefit, including those ly and indirectly contribute $25 billion to in Saldanha Bay, South Africa; Singapore; and Russia’s economy over the life of the project.” Nova Scotia, Canada, where there is a base The ConocoPhillips chief suggested that Timan- already set up to accommodate Urals-quality Pechora rivals the North Sea and Alaska in terms crude. of remaining reserves. The U.S.–Russian Commercial Energy Another good example of the future promise Summit speakers all stressed the significance of of this region, according to Dunham, is the convening such a historic event. The consensus Shtokman gas project, in which ConocoPhillips was that one of the key hurdles that must be is teamed with Gazprom to develop this giant overcome is the existing commercial framework field in the Barents Sea. Dunham said, “The in which foreign companies operate in Russia’s Shtokman field will be one of the next major energy sector. projects to maintain Russia’s position as a lead- Without reforming the weak PSA legislation ing supplier of natural gas to the world econo- currently in place to guarantee U.S. firms a con- my.” While full development of the Shtokman sistent and fair fiscal regime throughout the field will require $20 billion, the project is antic- investment, development, and revenues phases ipated to generate some $200 billion in revenue of a project, American companies may decide to for Russia over its 50-year lifetime. pass on even the less commercially risky oppor- One novel idea for U.S.–Russian energy coop- tunities in Russia. As ChevronTexaco’s eration that Russian government and industry Robertson pointed out, “PSAs have the ability to officials are broaching is for the two nations to attract large amounts of capital that not only can establish an international strategic stockpile of open up the frontier but will build infrastructure

10 that will facilitate development of Russia’s ments and tens of thousands of new jobs for the Continental Shelf.” However, as evidenced by Russian people,” he concluded. other viewpoints presented at the summit, there Russian energy minister Yusufov, in his own is clear resistance within the Russian energy sec- concluding remarks, noted that “we made a uni- tor elite and parts of the Russian government to form conclusion [at the summit] that companies changing the status quo. from our countries must work together to In his concluding remarks, U.S. commerce resolve this problem of world energy market sta- secretary Evans stressed that while the summit bility by increasing supplies and by participating could indeed be deemed a success, “we have a in joint projects, both in Russia and in third- long way to go and we have great challenges and world countries, where knowledge and experi- responsibilities in front of us.” He added, “You ence of our specialists will be out to use. When cannot increase economic development in this the transportation network is established and world without a steady, stable, secure, and expanded, Russia will be able to regularly supply diverse dependable supply of energy. The world oil and oil products to the American market.” will look to these two countries right now to pro- Furthermore, Yusufov said, “We invite American vide the leadership in that arena.” companies and financial institutions to support Evans also stressed Russia’s growing role in implementation of such projects.… We await the future in terms of gas supplies to interna- specific proposals from them.” tional markets. “Heretofore, natural gas has Earlier in the summit, both U.S. energy secre- been confined to continents, because that was tary Abraham and Russian economic trade and the only way you could transport it effectively or development minister Gref emphasized that economically. We’re rapidly moving into a world while their respective governments can do much where natural gas will be moved around the to pave the way for closer cooperation between world, which is why Russia will play such an American and Russian firms in order to further important role in providing energy supplies in develop Russia’s energy sector, the bottom line is the years ahead,” the secretary said. that it is up to the private sector in both coun- ConocoPhillips chairman Dunham warned tries to follow through. that time is of the essence for American and Said Abraham, “To succeed, the U.S. and Russian firms to move forward on crucial energy Russian governments do have an important role projects that will benefit both nations. Said to play. Our job is to create the framework of Dunham, “Incremental investment will sustain laws and rules that will allow our companies to near-term [Russian] production, but it isn’t form partnerships with confidence in the securi- enough to create a sustainable future. Russia will ty of the arrangements, including the sanctity of experience a decline in production by the end contracts.” On his part, Gref told summit atten- of the decade if new large reserves are not dees that “our government will do our best in brought on line in the next few years.” order to facilitate projects that you would point He pointed out that major projects cannot be out as the most attractive and most efficient and developed quickly, as they require negotiation be assured that they will be supported by our and many years of construction. “This means government, such as developing exports to the that negotiations need to be finalized soon and U.S. market and to other developing markets.” PSAs quickly approved.… Introducing effective The summit concluded with the signing of a PSAs in Russia means $40 billion in direct invest- joint U.S.–Russian communiqué stressing the

11 importance of continued cooperation in the Please view our website at http://www.bakerinstitute.org energy area and the creation of a commercial for further information about the Baker Institute. For other inquiries and address changes, we may be reached at 713- working group that would meet throughout 348-4683, fax 713-348-5993, or by e-mail at [email protected]. the year to recommend next steps for the The Baker Institute Study is printed on recycled paper. U.S.–Russian initiative. A second summit is being planned in Moscow for 2003. This publication has been made possible through the generous support of The Cullen Foundation.

JAMES A. BAKER III INSTITUTE NONPROFIT ORG. FOR PUBLIC POLICY–MS 40 U.S. POSTAGE RICE UNIVERSITY PAID P.O. BOX 1892 HOUSTON, TEXAS HOUSTON, TEXAS 77251-1892 PERMIT NO. 7549