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Russia’s Pipeline Game

By Sergei Blagov

Russia has sent signals that it could clear the way for construction of private oil pipelines as a way to increase petroleum exports to the West. The move, if it takes place, would signal an end to the long battle between Russia's private oil companies and the state pipeline monopoly Transneft, opening the door to a $4.5 billion project for shipping oil to the United States and other Western markets.

Russia's oil pipeline monopoly OAO Transneft has been opposing the private project, which would build a line from western Siberia to the ice-free Arctic port Murmansk. Despite its distance, Murmansk is closer to the U.S. market than the Persian Gulf.

Russia’s oil majors -- led by embattled YUKOS, including LUKoil, Tyumen Oil Company (TNK), and Sibneft -- have been lobbying in favor of a new U.S. export route through the Arctic port of Murmansk. The project, which is scheduled to start exporting in 2007, would pump up to 80 million tons of oil per year, or 1.6 million barrels per day.

By building private pipelines, Russian private companies aim to be free of direct Transneft control over export volumes and transit fees. For instance, Transneft has requested a tariff increase of 9 percent-11 percent in 2004. Transneft didn't increase the fees it charges oil companies in 2003 but it requires hikes this year to finance pipeline expansion and upgrades along existing routes.

Transneft, which now ships most of Russia's oil, boosted the capacity of an oil pipeline and a Baltic Sea oil port by two-thirds earlier last November month and expanded the link by another 40 percent in early 2004. The pipeline and the Primorsk port will be hauling 845,000 bpd by spring.

Transneft said it spent about $700 million to build the pipeline and the oil terminal at Primorsk, north of St. Petersburg, and plans to spend another $500 million on expansion.

In the meantime, government control over Russian oil pipelines has been cited as yet another hurdle hampering development of the country’s oil market. Russia has 46,800 km of pipeline some of which is more than 30 years old. Some pipelines have been modernized, but modernization of the trunk pipeline network remains a priority. The existing pipeline network operates at 99 percent capacity, limiting Russian oil exports to 4 million bpd.

There are also important new pipeline projects such as the Yamal – Germany project, which will require the installation of 12,000 kilometers of large diameter pipeline; or the $5 billion North European Pipeline designed to deliver 30 billion cubic meters of gas to Germany, Holland and UK.

The government controlled monopolies that control Russian oil transport and the natural gas sector are stunting industrial growth and undermining the interests of the state and of oil corporations, Russian LUKoil’s founder and chief Vagit Alekperov stated last year. "It is obvious today that state monopolism in any of its manifestations hinders the development of the Russian oil and gas sector," Alekperov said.

Russian companies "have all the necessary resources" to boost production to 10-11 million bpd by 2010, from 8 mm bpd at present, Alekperov claimed, adding that the only obstacle blocking this growth is the lack of space in the country's crowded pipelines. "Russia has an acute need for 2.6-3 million bpd of new pipeline and loading capacity," Alekperov said. But it was practically impossible to attract the $10 billion to $15 billion needed to finance such an expansion as long as the construction and operation of pipelines remained under the control of a state monopoly, he said. LUKoil’s leader stopped short of naming either state-run pipeline monopoly Transneft, which controls Russia's oil pipeline network, or gas giant Gazprom, also controlled by the state.

The moves to expand capacity of the Russian oil pipeline system have been seen as an indication that Moscow will keep raising production and challenging the Organization for Petroleum Exporting Countries (OPEC), while pursuing policies aimed at the U.S. market. Russian companies are trying to capture a 10 percent share of the U.S. oil market, offering an alternative to OPEC. In 2003, Russian oil accounted for about 1 percent of U.S. imports.

Russia is sitting on the world's richest natural wealth, priding itself with an impressive ranking in the oil ratings. With the country's proven 12 billion metric tons of oil deposits, Russia is the world's second biggest oil producer, generating some 8 million barrels per day (bpd). It is also the world's biggest natural gas producer. Russia’s natural gas output reached 580 billion cubic meters in 2002, while the country’s reserves are some 47 trillion cubic meters.

Subsequently since 2000, Russian economic growth has been driven by the oil and gas sectors. Despite a history of resistance to foreign participation in the industry, Russian companies now increasingly appear to see partnerships with foreigners as an acceptable compromise between the perceived need to keep the industry in Russian hands and the need to attract foreign investments.

The Russian Ministry of Energy believes that foreign investment of up to $70 billion could be attracted into Russia’s oil sector over the coming decade. Offshore the Russians are looking to develop oil and gas reserves in the Northern Seas (Barents, Kara, Pechora & Chukotka Seas), Sakhalin, the Black Sea and the Caspian Sea. Future onshore oil exploration work is focused on a number of sites in Western Siberia (Tyumen, the Yamal Peninsula, Khanti-Mansiisk, Tomsk, Omsk, Novosibirsk), European North (Arkhangelsk, Komi, Yamal Nenets and Timan Pechora) Volga-Urals (Udmurtiya, Orenburg) and Eastern Siberia.

Yet despite some domestic hurdles, Russia's rising oil output has confounded OPEC. But in spite of growing oversupply and a government promise to cut back, Russian producers are showing no signs of slowing down. In January 2002, the Russian government indicated it was considering a plan to create a strategic oil reserve, which could help to sop up the excess. But no more has been heard of the idea.

Russia has been keen to cooperate with OPEC as an “independent” oil producer, presumably so as to buoy oil prices in the near term. Riding on top of hydrocarbon exports, Russian government officials have depicted a rosy picture of the country's booming economy. President Putin has promised to double the country’s GDP by 2010 and pledged that the average Russian will "be happy" also by 2010, although that magic date is well after the expiration of his maximum constitutional presidential term. However, there have been warnings that continued over-reliance on oil and gas may eventually push the nation into a vicious circle of debt crises and an increasing dependence on commodity prices, a pattern well known among developing nations.

Editor: Dr. Scott B. MacDonald, Sr. Consultant

Deputy Editors: Dr. Jonathan Lemco, Director and Sr. Consultant and Robert Windorf, Senior Consultant

Associate Editor: Darin Feldman

Publisher: Keith W. Rabin, President

Web Design: Michael Feldman, Sr. Consultant

Contributing Writers to this Edition: Scott B. MacDonald, Keith W. Rabin, Robert Windorf, Sergei Blagov, Darrel Whitten and Jonathan Hopfner

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