The Political Economy of the Russian Oil and Gas Industry by Michael Bradshaw*
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The Kremlin, National Champions and the International Oil Companies: The Political Economy of the Russian Oil and Gas Industry by Michael Bradshaw* On 18 February 2009, the Russian President Dmitry Medvedev officially opened Russia’s first liquefied natural gas (LNG) plant built by the Sakhalin Energy Investment Company (hereafter Sakhalin Energy) at Prigorodnoye on the southern shores of Sakhalin Island, near the town of Korsakov. This is the first LNG plant in Russia and is at the heart of the Sakhalin II project, one of the largest integrated oil and gas projects in the world. The final cost of the project is unknown, but it will be well over $20 billion. When fully operational, the plant will have a capacity of 9.6 million tonnes a year (13.3 bcm) and the majority of its output will be exported to nearby Japan, with South Korea and North America also being major consumers. At the Opening Ceremony, Sakhalin Energy’s CEO Ian Craig said: ‘Sakhalin has now firmly established its position on the global energy map. When the Sakhalin II project is fully on stream, it will supply around 5 percent of the world’s LNG and make a significant contribution to strengthening global energy security’.1 At the same ceremony, Christopher Finlayson, Chairman of the Board of Directors of Sakhalin Energy, said: ‘This achievement is a take-off point, which opens up a new era in the history of Sakhalin. This has only been made possible thanks to the cooperation between Sakhalin Energy and its shareholders, the Russian Federal Government and the Sakhalin Oblast authorities.’2 The Sakhalin II project is a major achievement, but the congratulatory remarks at the Opening Ceremony belie a difficult history, as the recent fate of the project has been synonymous, in the eyes of many western observers, with the rise of resource nationalism in Russia. This article explores the changing political economy of Russia’s oil and gas industry since Vladimir Putin became President in 2000, and it presents the Sakhalin projects as a case study of the Kremlin’s changing attitude to the role of the international oil companies (IOCs). It then considers the impact of the current global economic crisis on Russia and assesses how Russia’s changed economic fortune might alter attitudes to foreign investment in its oil and gas industry. However, before embarking on this more detailed analysis, the first section addresses two key context- setting questions: how important is Russian oil and gas production to global energy security and how important is the oil and gas industry to Russia’s economic performance and foreign policy aspirations. The Global According to BP’s Statistical Yearbook, at the end of 2007 Russia held 6.4 percent of the Importance of world’s oil reserves and in 2007 produced 491.3 million tonnes of oil, accounting for 12.6 percent Russian of world output, just ahead of Saudi Arabia. Russia is not a member of OPEC but has increased its Oil and Gas contact with the organisation of late and has suggested appointing a permanent envoy. At the same time, in 2007, Russia accounted for 25.2 percent of the world’s natural gas reserves and produced 607.4 bcm of natural gas, accounting for 18.8 percent of total world output. Prime Minister Putin has at times supported the idea of creating a gas cartel similar to OPEC, but the very different contractual basis and infrastructure demands of the gas trade make this unlikely. Russia has supported the creation of a Gas Exporting Countries Forum (GECF) to counter what it sees as the IEA/EU consumers club. (Editor’s note. Please see Edward Kott’s article “Not so GEC fast” in the February 2009 Geopolitics of Energy for a detailed analysis of the gas cartel issue). *Michael Bradshaw is Professor of Human Geography and former Head in the Department of Geography at the University of Leicester, UK. He holds a PhD from the University of British Columbia, Canada. His research centres on resource geography with a focus on the economic geography of Russia and global energy security. He is an Honorary Senior Research Fellow in the Centre for Russian and East European Studies at the University of Birmingham, an Associate Fellow of the Russia and Eurasia Programme at Chatham House in London, and a Visiting Senior Research Fellow at the Oxford Institute for Energy Studies. Mr. Bradshaw can be reached at [email protected]. 2 MAY 2009/GEOPOLITICS OF ENERGY Russia’s recent prominence as a major oil producer is in marked contrast to the situation in the early 1990s. In the late 1990s, and for most of the current decade, Russian oil and gas production has increased on a steady basis; between 1998 and 2007 oil production increased by 61.5 percent, and this added production has been critical in meeting the growing demands of countries such as China and India (see Figure 1). In other words, without the rebound in Russian oil production, global supply would have been even tighter. However, much of the production surge was production delayed from the period of ‘transitional recession’ in the early 1990s when domestic demand was severely depressed; but a significant amount was also due to the application of enhanced oil recovery techniques by western oil field services companies and more recently TNK-BP, as well as some recent investments in new fields, predominantly by Lukoil. During the second half of the 1990s, Russia’s oil companies were in the hands of the Oligarchs, who, faced with political uncertainty and insecure property rights, sought to produce and export as much oil as they could to earn money. For example, between 2000 and 2004 Yukos doubled its oil production.3 The net result was the sweating of existing production assets with relatively limited investment in exploration and development of new fields. The situation in the gas sector is structurally very different because Gazprom has remained the monopoly producer and the de facto state control means that it is required to meet domestic demand at very low prices and often without payment. However, it has had the safety net of long term export contracts with longstanding customers in Western Europe. In fact, exports to Europe have traditionally accounted for about 25 percent of Gazprom’s production but have delivered 75 percent of its revenues. In 2006, Russia accounted for 43.3 percent of the EU-27’s gas imports, or about 25 percent of total EU gas consumption. But Gazprom also failed to invest sufficiently in renewing its existing infrastructure and in developing new fields, so much so that prior to the current global recession it was feared that it would not be able to meet its domestic obligations and maintain an exportable surplus. With demand depressed, this now seems less of a problem, though Gazprom may struggle to finance its ambitious plans to develop new fields on the Yamal Peninsula in West Siberia and at the Shtokhman field offshore in the Barents Sea. Yamal is essential to replacing Gazprom’s aging fields in Siberia and is a much larger undertaking that remains a priority, while Shtokhman is an exported-oriented project that could be delayed without compromising domestic plans.4 Figure 1: Russian Oil and Gas Production, 1985-20075 GEOPOLITICS OF ENERGY/MAY 2009 3 The key point is that while Russia’s oil and gas production has been crucial in meeting rapidly growing demand in recent years, there are currently doubts about the sustainability of its oil production, which, according to Energy Ministry data, declined in 2008 by about one percent compared to 2007 – with exports declining by five percent.6 Both the oil and gas sectors require substantial investments in the near term to develop new fields and their associated infrastructure. The rebound of Russian oil production happened at a time when world oil prices also increased rapidly. This helped fuel a period of economic growth and recovery. Despite government rhetoric, while Russia’s economy recorded healthy growth rates, it failed to reduce its reliance on oil and gas revenues through diversification. In 2006, revenues from the hydrocarbon sector contributed about half of the federal budget. Oil, oil products and gas contributed 59 percent of Russian exports in 2007, with oil and gas providing 25-30 percent of GDP.7 Russia’s economic recovery brought with it political confidence and President Putin proclaimed Russia to be an energy superpower. However, many observed that natural resource wealth is not a reliable basis upon which to re-build an economy the size of Russia’s, and there was growing consensus that the country was exposed to the resource curse, with a fall in energy prices foreboding severe consequences.8 This was something that the Russian Government clearly recognized, so it set up a stabilization fund to siphon off the excessive rents being generated by oil and gas exports. In a highly provocative, but persuasive, analysis, Clifford Gaddy and Barry Ickes suggest that the policies of high levels of taxation and increased state control over the oil and gas industry were explicitly designed to capture rents and reduce the potential for investment in new, high risk projects, which might subsequently turn out to be unprofitable if prices were to fall.9 The Domestic In their analysis of the significance of resource rents to the Russian economy, Gaddy and Significance of Ickes observe: Russian Oil and Gas: Resource Russia is the second-largest producer of oil and the largest producer of Rents, and natural gas in the world. The abundance of these and other resources Boom and Bust has been a key determinant of Russia’s economic evolution for decades.