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Bank Rossii Eases Further As Russia's Economy Contracts At A Record Rate

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Saturday, May 3, 2008

Russia's Oil Problems

Russia, which is the world's second-largest oil supplier, produced the lowest volume of crude in 18 months in April as ageing fields and rising costs threaten the country with the first annual decline in oil output in a decade. Production dropped to 9.72 million barrels a day (39.8 million metric tons a month), 0.8 percent less than in April last year and only slightly higher than in October 2006, according to data released today by CDU TEK, the dispatch center for the Energy Ministry. Compared with March, output fell 0.4 percent.

The harsh reality is that Russia's output may have peaked as producers struggle with aging fields, rising costs and increasingly remote new deposits. The finance and energy ministries are working on tax-cut proposals by July in a last ditch attempt to stimulate investment.

Exports through OAO Transneft, the state oil-pipeline operator, increased 6.7 percent from March to 4.5 million barrels a day. Russia increased the crude export tax to a record $340.10 a metric ton ($46.53 a barrel) on April 1 and plans to raise the levy again as of June 1. Exports dropped 3.8 percent compared with April last year.

Production from Lukoil, OAO Surgutneftegaz and Exxon Mobil Corp.'s Sakhalin-1 project continued to decline. State-run OAO Rosneft, which boosted output by about a third after buying bankrupt OAO Yukos Oil Co.'s assets last year, produced 2.29 million barrels of oil, 0.3 percent more than in March.

Lukoil pumped 1.79 million barrels a day last month, 0.6 percent less than in March and 2.7 percent less than in April last year. The company cut its growth target to 1.5 percent this year after delays starting the Yuzhno-Khylchuyusskoye field in the Timan-Pechora region.

Sakhalin-1, in which Rosneft owns a stake, pumped 204,900 barrels a day, 2.8 percent less than in March and 8.1 percent less than last year. The project, off Sakhalin Island to the north of Japan, averaged 225,000 barrels of oil a day last year.

The Exxon Mobil-led project, where production peaked last year, helped Russia boost output 2.2 percent in 2007. The project may pump 29 percent less oil this year, as the Chaivo field goes into decline and OAO Gazprom holds up sales of the project's natural gas to China, a Rosneft official said in February.

TNK-BP, the Russian venture that accounts for a quarter of BP Plc's output, pumped 1.57 million barrels a day last month, 0.3 percent more than in March, although 2.8 percent less than in April last year. OAO Slavneft, which TNK-BP owns equally with state-run OAO Gazprom, continued to decline.

Gazprom's oil arm, OAO Gazprom Neft, said earlier this month it will more than double crude output by 2020 to about 100 million tons a year through acquisitions of existing producers and new licenses.The unit pumped 816,000 barrels in April, including Slavneft, 0.7 percent less than in March and 6.5 percent less than a year earlier. Surgutneftegaz, Russia's third-largest independent oil company, produced 1.23 million barrels a day, little changed from March and 5.4 percent less than in 2007.

For Russia'a output to increase in the long-term, massive investments are needed to develop fresh deposits in western Siberia and to tap more remote provinces in eastern Siberia and the Arctic. Leonid Fedun, Lukoil vice-president, says Russia needs about $300bn in investment during the next eight years simply to keep production at current levels.

But many projects are being held back by a difficult fiscal and political regime that began with the break up of Mikhail Khodorkovsky’s Yukos by the Russian state after the tycoon’s arrest in 2003 over tax charges. Another problem is access to new fields, which is limited by a new law to companies with more than 51 per cent Russian participation. The process of handing out licences for these fields has been delayed for years while the state determines how many of them are to be considered “strategic”.

The state takeover of Yukos led to uncertainty about the investment climate as other private companies were picked off by the state. Russneft had been Russia’s fastest growing oil major until last year, when its owner, Mikhail Gutseriyev, fell on the wrong side of the authorities and fled Russia for the UK with a warrant out for his arrest. The company, which Mr Gutseriyev had developed from scratch in 2002 to produce 300,000 barrels per day, is now in administrative limbo, allegedly owing more than $800m in back taxes.

Since Yuganskneftegaz, Yukos’ main production asset, was taken over by Rosneft, the state-controlled oil major, in December 2004, the state’s direct and indirect share of the oil industry has risen to more than 50 per cent from 28 per cent, according to Chris Weafer, chief strategist at Uralsib investment bank in Moscow.

The takeovers by Gazprom and Rosneft have used up funds that otherwise could have been spent developing fresh fields, says Vladimir Milov, a former deputy energy minister who now heads a think-tank about energy policy.

Since 2003, direct investment in Russia’s oil industry has not kept pace with the more than three-fold increase in oil prices.

Fears about a production decline have spurred the government to review the tax regime, which takes more than 80 per cent of revenues of more than $27 per barrel. Ivan Mazalov of Prosperity Capital Management, an investment fund, calculates that, with oil prices at $110 a barrel, oil companies operating in Russia’s core production area of west Siberia see net income of only about $11 a barrel after taxes, export duties, operating and transportation costs.

An offer by Alexei Kudrin, finance minister, of $4bn in tax cuts per year “is nowhere near enough in itself to right the problems”, says Ronald Smith, of Alfa Bank in Moscow. Mr Smith reckons the government could rectify the problem by increasing export tariffs on oil products, which are set at such a level to send refining margins “off the charts” while lowering tariffs on crude.

But at fields in east Siberia, such as Surgutneftegaz’s Talakan venture and Rosneft’s Vankor, big tax breaks have already been won for the first oil extracted.


Anonymous said...

Is there a particular reason the decline in oil production is a bad thing for Russia? It's a bad thing for countries that rely on energy exports to run their economies, true enough. A decline in oil production would cut down on that "Too much money chasing too few workers" thing, ya know.

Edward Hugh said...

"Is there a particular reason the decline in oil production is a bad thing for Russia?"

Well yes there is really, but to see why we need to think in the slightly longer term - let's say 5 to 10 years.

From the point of view of the Russian economy as a whole the oil sector constitutes relatively "easy money" (I'm sure you won't feel this though if you actually work in the industry out in Siberia, or are one of those who is likely to be involved in developing the Yamal peninsula resources). What I mean by this is that in the short term Russia can close some of the living standards gap with the OECD simply on the basis of oil money, and the secondary derivitive activities of construction (as people buy houses etc) and financial services (the loans and mortgages to float the new life style) - ie a consumer boom.

What gets missed out in all of this in the short term is the development of a competitive industrial base which can make the economy sustainable in the longer term, since all the inflation we are seeing is just choking this off. This is the core of my argument.

Now, if we look around the OECD countries right now we can see that the construction driven consumer credit boom leg for economic growth is completely unsatisfactory on its own account - viz the US, the UK, Spain, Ireland etc now, Japan 1992, Germany 1995.

So at some point this internal momentum will seize up, as we have seen and are seeing elsewhere. Now if when it does seize up you don't have the capacity Japan and Germany have had to "re-invent themselves" as strong export driven economies then you have real difficulties sustaining economic growth (as we have been seeing over the last 10 years in Italy. Italy's construction driven component also peaked out in the mid 1990s, and Italy now has a congenital competitivesness problem).

So this is where the oil starting to decline (or at least become more and more costly and difficult to extract) could become a problem. If Russia has not by the time oil starts to become more problematic as a source of revenue developed the necessary industrial capacity to survive in this new economic environment then things can become very complicated and difficult.

"A decline in oil production would cut down on that "Too much money chasing too few workers" thing, ya know."

This is not so simple as it seems, since strong bouts of inflation can be followed by severe bouts of deflation, which is of course "too little money chasing too many people, and too many dollar bills stashed away in mattresses".

I think the key point is that Russia's population is not simply declining, it is declining and AGEING.

So Russia is going to have a much higher elderly dependent ratio twenty years from now. This population will need to be supported, and to offer this support you need economic growth, and again this is where the presence or absence of an industrial base (and high tech agriculture I suspect in the Russian case) becomes important.

Last week Claus Vistesen posted something on the Demography Matters blog about Germany, and at the end of the piece he cites recent research by McKinsey (and other sources) which tend to suggest that between now and 2020 a further 10 percent of the German population can fall into poverty just due to the effect of ageing alone. Obviously Germany is a lot richer than Russia. Just imagine what happens once all this starts happening in Russia.