The fragile foundations of the Russian oil sector
In 2011, oil production in Russia reached 511.3 million tonnes (10.26 million barrels per day), the highest level since the collapse of the Soviet Union and the highest in the world together with Saudi Arabia. Russia's declared goal in its oil policy is to maintain annual output at around 505 million tonnes over the next few years and increase it to 535 million tonnes by 2030. However, despite the fact that proven Russian oil reserves are still vast, and that Russia probably has very large undiscovered deposits, it will be practically impossible to achieve this goal. As a result of structural deficiencies in the market structure, a significant fall of Russian oil production is almost inevitable. The degree of the decline will depend on the actions the government takes in its fiscal policy and the investment climate in general. The opening of Arctic deposits for some Western oil majors, widely reported on recently, will not be a solution for the problems of the Russian oil sector.
|(c) EUobserver.com/ Notat|
Before we turn to a discussion of why the Russian oil sector in trouble, let us first take a look at some of the official forecasts of oil production levels, which can be found in various Russian documents. What is striking about them is that they differ significantly from one another. The Energy Strategy to 2030, the major official energy policy document of the Russian government, envisages that oil production will grow by approximately 5% within the next twenty years to reach an annual level of 505-525 million tonnes in 2020-2022 and 530-535 million tonnes in 2028-2030, i.e. just short of 11 million barrels per day (mbpd). By contrast, the Strategy for Geological Sector Development to 2030, the key document regulating development of Russia's mineral resources complex, prepared by the Russian Ministry of Natural Resources and the Environment, foresees that oil production will fall in 2015 to 490 million tonnes, and will then start growing a little to reach the level of 500 million tonnes in 2020 and 530 million tonnes in 2030.
Another forecast is provided in the General Scheme of Development of the Oil Industry to 2020, which was prepared by the Ministry of Energy in co-operation with a number of Russian and foreign scientific and research centres. This presents two possible scenarios of oil production levels in Russia to 2030, with very different outcomes. According to the first one, called the ‘planned scenario’, if the present environment in which oil companies operate is maintained, oil production will fall fast within the next few years to 454 million tonnes in 2015, 403 million tonnes in 2020, and as low as 228 million tonnes in 2030. This would mean a drop of 20% within the next ten years and 55% in twenty years.
According to the second scenario, which is called the 'designed scenario', if investments increase significantly and the government adopts a good policy, including above all a liberalisation of the fiscal system, oil production will growing within the next few years to reach a maximum level of 571 million tonnes in 2017. However, after that date production will rapidly fall to 547 million tonnes in 2020, 470 million tonnes in 2025 and 346 million tonnes in 2030. This means that the suggested tax breaks will be able to hold off the reduction in Russian oil output for a few years but not prevent it, and its level in twenty years could be 31.5% lower than now.
Of all the documents prepared by Russian state institutions containing oil production forecasts, the General Scheme of Development of the Oil Industry provides the most pessimistic picture, although it does include the reservation that the production level after 2020 "will depend on the geological work conducted, new fields discovered and the demand for oil".
Although the alarmist forecast in the General Scheme may have been in part intended to lobby policymakers to change the fiscal system, it should still be taken seriously. In fact, most Russian experts are of the opinion that the official forecasts, especially those provided in the Energy Strategy to 2030, are overly optimistic, and that production is bound to fall in a decade or so. The only unknown is how much it will decline.
A good example of a non-governmental forecast was presented in 2010 in Neftegazovaya Vertikal, a Russian magazine dedicated to the oil and gas industry. Its authors predict that production will peak in 2015 and after this date will fall gradually to reach 498.1 million tonnes in 2020, 478.1 million tonnes in 2025 and 443.1 million tonnes in 2030. These conclusions are in line with the predictions of many other Russian experts, who believe that oil production levels will depend on the government's policy but generally expect them to fall.
Similar forecasts have been made by the International Energy Agency (IEA) in the recent World Energy Outlook. According to the IEA's estimates, oil production in Russia will remain at the present level until 2015, and will then start falling: 7% by 2020 and 3.5% by 2025, to remain thereafter at that level until 2030-2035. Thus, according to the IEA, production will fall by approximately 50 million tonnes over fifteen years.
These expert forecasts are similar to some of the estimates from Russian energy companies. At a presentation for investors in London at the end of March, Lukoil, Russia's second biggest oil company,
|Even in the most positive scenario presented by Lukoil, production in 2020 will be lower by 10%|
From these prognoses it can be concluded that the most likely scenario for the Russian oil sector is a slight increase in oil production (by several million tonnes annually) in the next two to three years, after which production will fall below the level of 500 million tonnes. The degree of the decline will depend on the measures taken by the government, above all in terms of fiscal policy and the investment climate in general. If the government pursues the right policies, the decline of production may be limited to a few tens of millions of tonnes by 2030. However, if the government does not act properly, it cannot be ruled out that production could even fall below 400 million tonnes by 2030.
The main reason for the expected production decline is the deteriorating condition of oil fields in Western Siberia, the key Russian oil production centre. Total output there fell by 6% in 2006-2011 and, according to most forecasts, will continue to fall in the future. The situation is especially bad in the oil fields in the Khanty-Mansi Autonomous Region, where over 50% of total Russian oil production takes place. Russian experts warn that the observed fall is unaffected by increasing investment activity of oil firms, the significant intensification of drilling and the extensive use of technologies to improve production efficiency. At best, output in this region will be maintained at a slightly lower level than now. More likely, however, production will start to fall rapidly in the near future. Even the Energy Strategy 2030 foresees that oil production in Western Siberia will fall irreversibly, by 10% within the next five years.
The situation is expected to show even greater deterioration in the Volga-Ural region, Russia's second most important oil province, where - according to Energy Strategy 2030 - output will be reduced by 20% in ten years and more than 40% by 2030 in comparison to the level in 2008. This is due to the high degree of depletion of the old fields, extensive production since 1991, and the fact that production is unprofitable in some fields in the present fiscal environment.
The recent increase in Russian oil production may have had a reassuring effect on the government by creating the illusion that the situation in this sector is good. But this rather small production growth was
|The recent increase in Russian oil production may have had a reassuring effect on the government by creating the illusion that the situation in this sector is good|
But neither these new fields nor those where production is due to start soon, i.e. mainly the fields in Eastern Siberia and the Caspian Sea shelf, will be able to compensate for the output fall in the traditional oil provinces in the medium and longer term. In fact, all official Russian documents agree that Western Siberia and Volga-Ural will remain the key oil producing regions for at least twenty years, not just in terms of production volume but also with regard to new reserves as a result of newly found fields.
A major problem for the Russian oil sector is the fact that no new large fields are planned to be put into operation in the immediate future. Energy Strategy 2030 envisages that the significance of oil production in Eastern Siberia and the northern part of Krasnoyarsk Krai (Vankor) will grow. However, its forecasts, according to which the total share of these regions and the Far East in overall Russian oil production will reach 18–19% by 2030, are overly optimistic. One of the goals set by the Russian government is to completely fill the ESPO oil pipeline (from Eastern Siberia to the Pacific Ocean), whose annual capacity is to reach 80 million tones (1.6 mbpd) after 2015. But it seems impossible that this goal will be attained within the next decade or so. Even the Energy Strategy 2030 predicts that oil output in this region in twenty years will reach 75 million tonnes at best. But many Russian experts believe that production forecasts for this region fail to correspond to data on available oil reserves. The fields already discovered and developed will be able to produce 50 million tonnes of oil annually at best. Reaching the level of 80 million tonnes as the government assumes would require a doubling in the intensification of geological and exploration work.
In Eastern Siberia the level of geological exploration is still low. Another problem is the fact that oil reserves within the reach of the ESPO oil pipeline, i.e. those which do not require building new, expensive oil pipelines, are limited to just 667 million tonnes as proven reserves and 857 million tonnes as probable reserves. This is too little to fill the ESPO. The new fields require much more complex technologies and are predominantly located in areas with no infrastructure whatsoever, making their operation expensive. It is estimated that some $160 billion needs to be invested up to 2030 in Eastern Siberia and the Far East to fulfill the region's potential.
|Vladimit Putin opens the Russian section of the Russia-China oil pipeline in August 2010 (c) AP|
A number of problems have accumulated in the Russian oil sector over the past few years. These problems have been aggravated by the lack of response from the Russian government.
One of the key issues is the insufficient level of investment expenditure, including on geological and exploration work and on the development of new fields. The oil sector will soon start to feel the consequences of the chronic underinvestment over the past few years.
In addition, the quality of existing oil reserves is deteriorating, and extracting them will become more complicated due to the complexity of the geological structures in which they are located (difficult to extract oil makes up 60% of total reserves), the harsh climatic conditions and the lack of a developed infrastructure and necessary technologies.
The Energy Strategy 2030 and the IEA agree in their estimates that investments necessary in the Russian oil sector within the next twenty years should be at a level of US$30 billion annually. If we consider that $25 billion was invested in 2011, Russian oil companies need to generate an additional US$5 billion on an annual basis. A thorough fiscal reform would make this possible. The reduction of export duties in 2011 and the lifting of the tax on the extraction of mineral Resources (NDPI) for some future oil regions, show that the government is aware of the need for reform, but these measures are not enough. The ruling class fear the consequences of a decrease in oil-generated budget revenues. Therefore they are reluctant to take measures that will lead to lower revenues in the short term, even though they will lead to much higher revenues after 2020.
Fiscal system reform is not the only thing that is needed. It is also necessary to end the existing informal division of oil companies into two categories. The first category includes state-owned companies and those linked to the government elite, which are favoured in receiving access to new fields and supported in various ways. The second category includes private firms which cannot count on any privileges and are consequently scaling down their investments in Russia and shifting their activity to international markets.
Another issue which needs to be changed is the policy towards foreign investors. Although it seems that, with lighter fiscal burdens, Russian oil companies would be able to generate the funds needed for
|Although it seems that, with lighter fiscal burdens, Russian oil companies would be able to generate the funds needed for investments, they are still without the technologies necessary to exploit promising new deposits|
Summing up, it should be stressed that the future of the Russian oil sector depends above all on government policy. Unless the ruling class change their approach to this sector and stop treating it primarily as a source of budget revenues, problems are bound to escalate. This will have grave consequences for the entire economy and the state, which is strongly dependent on income from oil exports.
One more key factor that will have a vast impact on the future of the Russian oil sector is the oil price. The development of most new fields and part of the old ones will be unprofitable at a price lower than $100 per barrel. A sustained lower oil price would spell catastrophe for the Russian state budget and the oil sector. This in turn might lead the government to shrink from reforming fiscal policy, with even worse consequences.
About the author
The author is an analyst at the Warsaw-based Centre for Eastern Studies (OSW). He deals with energy issues in post-Soviet Eastern Europe as well as the political situation in the countries of this region. Recently he published a study on the situation and future of the Russian oil sector. Available here: http://www.osw.waw.pl/sites/default/files/PRACE_39_en.pdf