Foreign Affairs: "The Battle for Energy Dominance" By Edward L. Morse and James Richard Part 2
<CONTINUED FROM UPSTREAM>
ROLL OUT THE BARREL
If the concrete plans of Russian and Central Asian oil companies and their international partners come to fruition, total cis exports from the former Soviet Union could equal Saudi exports within four years. The threat of a "northern" oil boom that Middle East producers first feared in the early 1990s is now real.
The one factor that constricts the ability of Russia and Kazakhstan to increase exports more than production capacity is infrastructure -- namely, inadequate pipelines and port facilities. But since September 11, export infrastructure has been enlarging and will accelerate. Most of the increased exports of the past two years have come from increased loading capacity on the Black Sea and in various terminals in the three Baltic states, but this imbalance, too, is changing. In 2001, oil began flowing from the 1,000-mile Caspian pipeline, which provides a direct route for Kazakh crude oil exports to world markets via the Black Sea. Controlled by Lukoil, Chevron, Shell, and ExxonMobil, the pipeline is expected to handle 1.5 mbd for export by 2012. And in the Baltic, Moscow is pursuing extensive plans for shipping out more oil. The new Baltic pipeline will deliver oil from Russia's far north and western Siberia, much of which is intended for Western markets, including the United States.
All of Russia's major oil firms are competing for European and U.S. market share, but it is Lukoil that is furthest along. The company has a long-term plan to become an international contender and sees itself as the legitimate "fourth sister" of industry leaders ExxonMobil, Shell, and bp Amoco. Lukoil expanded operations to southern Europe a few years ago by purchasing refining assets, pipelines, and ports in Bulgaria and Romania; it recently started to negotiate purchase of a refinery from Hellenic Petroleum in Greece. In 2000, it bought Getty's 1,300 gas stations in the United States. Although the stations are already partially supplied from Lukoil's refinery in Bulgaria, the company intends to acquire a large refinery in the United States to increase Russian deliveries to Getty's pumps.
But Russia's international acquisitions have not always gone smoothly. In 1997, three Russian companies, led by Lukoil, signed a $3.5 billion agreement with Iraq to develop the West Qurna field, which has an estimated 7.8 billion barrels of reserves. By 1999, the consortium was lobbying the Russian government to end U.N. sanctions on Iraq, which were hindering development. Several other Russian producers also have contracts with Iraq that cannot be implemented until the U.N. sanctions regime is over. Iraq has threatened to cancel all these concessions unless Russia starts developing. Complications have also arisen in Europe. In December 2001, Yukos failed to reach an agreement to purchase a stake in a refinery and offshore terminal on Lithuania's Baltic coast. The terminal would enable Russian producers to ship high-quality, low-cost refined oil products in large tankers to New York from Lithuania, a possible future NATO member. Whether or not the obstacles in Lithuania and Iraq can be cleared, however, Russian producers will continue to expand their influence into historical markets and beyond. In the coming months, several Russian firms will compete in privatization tenders for downstream oil assets in Poland, Latvia, the Czech Republic, Slovakia, and Croatia.
A NEW STRATEGY
Until September 11, the United States pursued two often conflicting goals: encouraging Russia to better protect U.S. corporate investments in the Russian energy sector, and assisting the Caspian countries in developing and exporting their own hydrocarbons, thereby avoiding pipeline routes through Russia.
Events are now squaring the circle. Russian companies and the Russian government are moving rapidly on improving the rule of law, but they are not providing significant advantages to U.S. and other foreign direct investors in the oil sector; Russian firms want to keep the "crown jewels" to themselves. Yet these same firms, intent on expanding abroad, are becoming more open to joint ventures with international firms when they require Western technology, particularly in the offshore areas of the Arctic Ocean. Meanwhile, the new environment of cooperation and Russian corporate interests in the Caspian countries have moved Moscow to support the independent export pipelines that expedite development schemes in Azerbaijan and Kazakhstan.
Even so, significant room remains for U.S. influence, whether good or bad. If it takes the wrong track, the U.S. government could prevent Russian industry from becoming more transparent. Unilateral economic favors dispensed by Washington, for example, could bankroll Russia's major oil firms with undeserved credit as a way to lessen OPEC's influence in the oil market. Such a politically motivated move would institutionalize the status quo by sheltering Russian companies from the demands of the marketplace. Ill-conceived investments enable corrupt managers to continue their mistreatment of shareholders and mismanagement of assets without sanction.
If the U.S. government desires to get more involved in supporting Russian oil exports, it must move beyond the knee-jerk reaction of siding with American firms in their disputes with their Russian counterparts, as was often the case before September 11. Equally important, U.S. overseas trade and development agencies as well as international financial institutions should ensure that the rule of law, including minority shareholder rights, has been honored before promoting credit lines to Russian producers.
The United States can also support legislation that further promotes property rights in the region. Transfer-pricing legislation, already implemented in Kazakhstan and under consideration in Bulgaria, can help stop domestic and foreign strategic investors from moving profits out of publicly traded subsidiaries. Such atrocious (and all too common) corporate behavior not only destroys minority shareholder value at the subsidiary level; it can also devastate burgeoning tax bases in emerging economies. In addition, Washington can aid the effort to stop such practices by improving the educational and training programs for tax officials and the legal systems that are required to implement such legislation.
In the oil and gas sector, Americans must help the Russians and the Kazakhs determine the most efficient export routes for Russian and Caspian oil and arrange financing for these capital-intensive projects. This move would be radically different from the policy pursued in the 1990s, when the United States pushed export routes that tried to free the Central Asian states from Russian and Iranian control rather than pursuing the most economically viable options. Moreover, Lukoil recently stated it would even consider participating in the U.S.-backed Baku-Ceyhan pipeline, which will bring oil from the Caspian to Turkey's Mediterranean coast. As elsewhere, global investors should be free to pick winners and demand corporate reform and increased production when economically justified. Investors remain the best positioned to make demands on those managers who still do not understand that the company's interests are aligned with the interests of its shareholders.
HOW LOW CAN YOU GO?
The emerging battle for market dominance between Russia and Saudi Arabia is a clash between two extremely different cultures and involves radically different agents. True, both the Russian and the Saudi governments are unusually dependent on the revenues generated by oil or gas exports. But this dependence aside, the Russian oil sector is a lot more like the United Kingdom's than it is like Mexico's or Norway's -- let alone that of the former Soviet Union. The Russian government has extremely limited powers over how Russian firms allocate their sales or investments. Moscow can encourage or limit access to pipelines under government control, but it cannot control what companies do.
In contrast, Saudi Arabia is governed by a royal family that sees its interests as part and parcel of the state it rules. The national oil company, Saudi Aramco, is the state's sole instrument for pursuing its aims. Saudi Aramco's commercial interests are those of its shareholder -- the state -- and the society over which its shareholder governs. On the Russian side, however, the state has become increasingly a representative institution that provides for the public good through taxes. Yet it owns a rapidly decreasing amount of the country's energy resources and enjoys no monopoly over the Russian oil industry. The state has ceded this terrain to a group of publicly traded companies eager to expand rapidly in a competitive international environment.
When Saudi Arabia and other OPEC members sought Russian cooperation last fall in managing the international oil market, they had a simplistic and wrong-headed view of Moscow's position. Encouraged after gaining the cooperation of Mexico, Norway, and Oman in a previously oversupplied market in 1998, the Saudis did not understand the new Russia. It was becoming better off financially, but its government remained too weak to actively limit the country's oil exports. Nor was Moscow so dependent on oil revenue that it had to cooperate with the Saudis. Thus Riyadh made a tactical error: it tried to blackmail Moscow by threatening a price war.
Russia did not take kindly to the threat. First, its biggest companies, which had worked so hard in raising oil production over the past two years, especially Yukos and Surgutneftegas, resented any attempts to limit their exports as unwarranted state intervention into corporate plans. They also saw the move as a violation of an explicit agreement between the government and the private sector, in which companies would become more transparent and pay taxes but remain free to grow with less government interference. Second, there was widespread Russian anger at the blunt OPEC effort to blackmail Moscow. Riyadh's oil policy was seen as an extension of Saudi support for Afghanistan's anti-Russian rebels in the 1980s, the independence movement in Central Asia in the late 1980s and early 1990s, the Chechnya conflict, and Islamic educational institutions in Russia -- all considered threatening to Russian interests. But Moscow's reaction was also calculating. Both Moscow and the Russian companies knew that Russia depended far less on the international price of oil than did Saudi Arabia. Some Moscow officials therefore welcomed a price war, which they saw Russia as outlasting. (The income and capital expenditures of Russian firms are ruble-based, so these companies benefit from a ruble depreciation against the dollar.)
Like Saudi Arabia, OPEC was also miffed. Russia's initial rebuff of the approaches of OPEC's leaders, when they sought Russia's cooperation in reducing output, angered virtually all its members. The OPEC countries were annoyed that Russia was increasing its output so aggressively at a time when OPEC countries were restraining themselves. And just as the Russians equated Riyadh's position on oil with Riyadh's support for anti-Russian institutions, the OPEC world saw a direct attack on its own values. From OPEC's perspective, Russia was stealing market share that rightfully belonged to countries with far deeper oil reserves.
From Moscow's perspective, however, Russia was reclaiming lost market share. Indeed, Moscow sees the history of oil in the 1980s as one of a price war declared by Saudi Arabia on all other oil-producing countries. The aforementioned Saudi-engineered price collapse of 1985-86 led to the implosion of the Soviet oil industry -- which, in turn, hastened the Soviet Union's demise. From this perspective, Moscow's companies were simply reclaiming the international market share that had been stolen by Riyadh 15 years earlier.
In any event, both sides decided to declare a truce by the end of 2001. Russia concluded that cooperating with OPEC and other independent oil producers was in its best interest -- for now. In the end, Moscow felt that a price collapse would be bad for the world economy and the stability of oil exports.
Despite the truce, however, the battle is not over. When it comes to compliance in preventing overproduction, Moscow and Riyadh remain suspicious of each other. Russia is increasingly convinced that it could withstand a price collapse better than any of the OPEC countries. Moscow has made no excuse for its inability to fully enforce compliance, but it knows that nature is on its side; tanker loading at the Black Sea and Baltic terminals is always reduced during the harsh winter months. Moscow also believes (rightfully) that its exports are far more transparent than those of OPEC members, whose exports are measured by journalists rather than by government customs data. And Moscow knows that Saudi Arabia has been exceeding its export quotas over the past year far more egregiously than anyone else has. Recriminations will fly from both sides in the months ahead.
In the long term, Moscow may have far more going for it than Riyadh. Yukos, Lukoil, and other companies are dynamic and growing, and they are now poised to recapture and expand on the production base of the former Soviet Union. Furthermore, they are highly integrated and are forming alliances with international companies, and so they can sell their growing output to enlarging networks in Europe, Asia, and the Americas. Through their joint ventures, they can tap the technology and capital of Western firms in developing new resources, especially in the Far East and the Arctic Ocean.
Riyadh, on the other hand, might have vast known reserves, but it also has a closed state monopoly. Most alarming, Saudi Arabia has been unable for 20 years to increase its production capacity. Nor is its position unique: few OPEC countries in 2002 have more production capacity than they did in 1990 or 1980. The exceptions are countries such as Algeria and Nigeria, whose governments have encouraged foreign investment in the petroleum sector. History does not look kindly on monopoly-company countries. Riyadh has only one clear weapon left: the spare capacity that can be unleashed whenever it chooses to punish those who would challenge its oil supremacy.
WINNERS AND LOSERS
Thanks to the potential growth of Asian and U.S. demand, there could be room in the future for both Saudi and Russian producers to gain market share if they cooperate. But it is more likely that the policies pursued by Moscow and by Washington will restructure the battlefield.
Although Russian oil is not nearly as large in its reserve base or as cheap to produce as Saudi crude, it remains vast and far greater than is generally recognized. Market forces have unleashed a dynamic transition in its oil sector that will allow Russia to challenge OPEC and Saudi Arabia. In an economy governed by market forces, Russian companies are poised to capture the lion's share of growth in demand in China, India, and even the United States, through joint ventures.
The cost structure of the Russian energy industry is a significant factor in the equation. As long as costs are largely ruble-denominated and the ruble is stable, Russian industry is protected from low oil prices, while capital investment flows are sheltered from price volatility. For the Russian government, the situation is more complex, but Russia is also more sheltered from low oil prices than are other exporting countries. Like OPEC exporters, it depends on revenues from export taxes. But unlike OPEC countries, it also takes in significant revenue from domestic sales and from taxes on huge natural gas exports to Europe. Thus the major question is whether Saudi Arabia can afford a sustained price war to block Russian and cis oil development. That feat might require oil at $10 a barrel for two years or more -- a situation as frightening for Riyadh as it is for other OPEC countries.
The critical element that Washington can add is a policy mix that would arrest the growth of U.S. oil demand by adopting a transportation policy that forces greater efficiency. This effort would take the post-September 11 world seriously. If both Washington and Moscow encouraged what their companies and publics already do -- increasing production in both countries while restraining demand in the United States -- the stage could be set for a very new petroleum world. The time has come to recognize that September 11 has opened new vistas for Russia, the United States, and OPEC.
<END>
.......................................................
RGD comments: Wishful thinking at its best. As long as the Neanderthals are setting the U.S. energy agenda for maximum profit and ability to gouge consumers, we can expect none of this efficiency stuff to gain any purchase, a'tall. |
