B&M \ About Russia \ Energy

Energy

Russia is a significant energy exporter. The key exports are oil and natural gas. Even though production of both has declined in recent years, consumption within Russia has declined even further so net energy exports have increased.

Russia’s total oil production fell nearly 23% from 1992 to 1998 after Soviet Union’s breakup, but has made a comeback in 1999 and 2000. From 7.86 million barrels per day (MMBD) in 1992, production fell to 6.07 MMBD in 1998, reflecting a decline in drilling and capital investment as domestic consumption dissipated. Higher world oil prices since March 1999 helped stimulate a jump in Russia’s oil output, to 6.30 MMBD in 1999 and a projected 6.62 MMBD in 2000.

Russia has an estimated 49-55 billion barrels of oil in proven reserves, but aging equipment and poorly developed fields are making it difficult to develop these reserves. The depletion of existing oilfields, deterioration in transport infrastructure, and an acute shortage of investment–aggravated by the country’s August 1998 financial crisis–may lead to further declines in oil production unless these trends can be reversed.

Oil companies are undertaking new exploratory drilling. In addition to further development of Russia’s Siberian region, several oil companies have joined forces to explore for oil and gas in the Arctic. According to Aleksandr Gavrin, Russia’s fuel and energy minister, the country’s future oil production will be determined mainly by world oil prices, the tax structure for oil production and refining, the application of modern technology at deposits with exhausted and low yield reserves, and new oil deposits in Eastern Siberia. Large amounts of capital, mostly from foreign investors, will be needed to develop new fields and to extend the life of existing oilfields, but analysts have argued that proposed changes to Russia’s legal framework for long-term investment in the energy sector will introduce potential conflicts of interest for domestic oil companies and may do little to simplify the process.

Russia initiated a two-step privatization process in 1993. The first phase, which involved organizing state-owned enterprises as joint-stock companies, ended in 1994 and resulted in the establishment of several vertically-integrated oil companies. The second phase, which has been ongoing since 1995, involves the auctioning off of large chunks of government shares in these companies. In 1999, the government auctioned 9% of Lukoil for $200 million (plus $240 million in investment commitment) and 48.7% of Tyumen Oil Company (TNK) for $90 million (plus $184 million in investment commitment).

The sale of an 85% federal stake in the Orenburg Oil Company (Onako) in September 2000 fetched $1.08 billion, more than double the asking price and a record for a Russian oil privatization. EvroTek, an affiliate of TNK, placed the winning bid. The sale has helped to demonstrate that oil privatization can be profitable for the Russian government. The successful sale of Onako could signal a new phase in Russia’s privatization, and could pave the way for the sale of Rosneft and Slavneft, the last two large state oil companies. The sale of Rosneft flopped in 1998, partly due to the country’s financial crisis. Russia’s Federal Property Fund says 19.64% of Slavneft and 25.5% of Rosneft will be auctioned off in 2001.
In October 2000, the EU agreed to help Russia develop its oil and gas reserves in return for a long-term energy supply commitment. This could help boost Russia’s oil exports. Currently, Russia provides about 20% of Europe’s natural gas needs and 16% of its oil supplies, but EU officials say they hope the energy pact will soon lead to a doubling of imports from Russia.

Russia’s financial crisis in August 1998 weakened the ruble and made the country’s exports more competitive, and higher prices on the world oil market in the second half of 1999 and throughout 2000 have led to a boom in Russian oil export revenues. Russian oil companies have been rushing to export their oil (resulting in a windfall of hard currency coming into the country) to such an extent that Russian officials have set export quotas in order to maintain an adequate domestic supply of oil. In 1999, Russian net oil exports totaled 3.96 MMBD, and in 2000 the country’s net exports are projected to increase to 4.16 MMBD. In addition to export quotas and higher taxes levied on oil exports, another problem facing exporters is the lack of export routes. Russia is maneuvering to become a major player in the exploration, development, and export of oil from the Caspian Sea.
Transneft is the state-owned company responsible for Russia’s extensive oil pipeline system. Many of these pipelines are in a state of disrepair, with Fuel and Energy Ministry figures indicating that almost 5% of crude oil produced in Russia is lost through pipeline leaks. Transneft lacks the funding to repair or upgrade many of these malfunctioning pipes, and the company’s focus instead has been on building new pipelines. In addition to those in the Caspian Sea Region, Russia has a number of new oil and gas pipelines planned or already under construction. Natural gas is the predominant fuel in Russia, accounting for nearly half of the country’s domestic consumption. With 1,700 trillion cubic feet (Tcf) in proven gas reserves, Russia has more than enough for itself, allowing it to export significant amounts of gas. In 1998, Russia produced 20.9 Tcf of gas and consumed only 13.8 Tcf, with the excess 7.1 Tcf exported, making Russia the world’s largest gas exporter.

Although the country’s natural gas production has dipped only slightly (8% from 1992 to 1999) during the transition to democracy, low investment has raised concerns about future production levels: production in the established West Siberian fields that account for 76% of Russian gas output is declining, while the planned development of new fields continues to be delayed as a result of lack of investment resources. Moreover, the Russian government’s authorities’ determination to keep domestic gas prices artificially low deters the production of associated gas by oil companies and forces Gazprom, the country’s natural gas monopoly, to look to export markets for hard-currency earnings.

Gazprom, which is 38% government-owned, dominates Russia’s gas sector. Gazprom controls more than 90% of Russia’s gas production, runs the country’s 90,000-mile gas pipeline grid and 43 compressor stations, operates trading houses and marketing joint ventures in many European countries, and holds one-fifth of the world’s natural gas reserves. In addition, Gazprom is Russia’s largest earner of hard currency, and its tax payments account for around 25% of federal tax revenues.

As a result of the approximately $2.7 billion debt of domestic gas consumers, Gazprom has been unable to meet all of its tax payments. The company continues to be hurt by low domestic prices, which are running at approximately 11% of export prices, and chronic non-payments. Gazprom has reduced gas supplies to the country’s electricity monopoly, Unified Energy Systems (UES), as a result of such non-payment.

Russian is attempting to liberalize its gas industry by ending Gazprom’s monopoly position. On November 9, 2000, the government ordered Gazprom to allow other companies to use up to 15% of its pipeline capacity. Most oil companies, however, produce a heavier form of gas that requires special refining before it can be transported in the pipeline. With low domestic gas prices and low levels of consumer payments, however, companies may decide it is not worth the cost.

Gazprom is under fire for its relationship with Itera, which has rapidly become Russia’s second-largest gas exporter. Minority shareholders in Gazprom have sent the government a detailed critique of Gazprom’s ties to Itera, arguing that Itera has been allowed to obtain valuable Gazprom assets at discounted prices. The European Bank for Reconstruction and Development is demanding clarification of the Gazprom-Itera relationship before it agrees to give Gazprom a $250-million loan. For its part, Itera, which has focused on gas exports, recently began its own gas production and signed a gas supply contract for the Sverdlovsk region, edging into the domestic gas market for the first time.

With low domestic prices, Russia’s gas industry is heavily dependent upon exports. In 1999, Russia’s gas exports outside the former Soviet Union were up by over 200 billion cubic feet (Bcf), to 4.5 Tcf per year, with exports to Western Europe increasing 350 Bcf. Gazprom supplies Europe with 25% of its natural gas, a share that Russia hopes to increase. Russia’s dispute with Ukraine over gas transit has prompted Gazprom to propose building a new pipeline in order to supply its European customers.

The proposed Ukraine bypass pipeline is just one of several new gas pipelines that Russia has in the works to increase its export capacity. The Blue Stream pipeline, which is currently under construction, aims to supply 564 Bcf of natural gas to Turkey when it is completed, is the centerpiece of Russia’s export diversification strategy. In order to guarantee sufficient gas for the Blue Stream pipeline, Russia has announced plans to import additional gas from Turkmenistan, making Russia a key player in the transit of Caspian Sea region natural gas.
Russia’s coal sector continues to undergo painful downsizing and restructuring. Although coal accounted for roughly 15% of Russia’s domestic energy supply in 1999, coal consumption has trended downward since the breakup of the Soviet Union. In 1992, Russia consumed 374.6 million short tons (Mmst) of coal; by 1998, consumption had fallen to only 262.6 Mmst. Russia remains the world’s sixth largest coal producer, but production has slide sharply since 1992. In that year, Russia produced 405.9 Mmst of coal, while in 1998, it produced only 272.6 Mmst — a 33% decline.

Years of poor management of the Soviet sector in the Soviet period, combined with a sharp decline in demand for coal during the early 1990s, significantly undermined the sector’s economic viability, and by 1993, government subsidies to the coal sector became unsustainably high, exceeding 1% of the country’s GDP, according to the World Bank.

Russia initiated a comprehensive restructuring of the coal sector in the mid-1990s, and with $800 million in financing provided by the World Bank, the government is in the midst of the second phase of the restructuring program. This phase calls for the closure of all unprofitable mines, the complete liquidation of the national coal company, RosUgol, and a substantially reduced subsidy level.

In addition, the plan includes funding for: 1) an adequate social safety net to affected workers, their families, and communities; 2) protection of Russia’s forests from further environmental damage from coal mining; and 3) maintenance and upgrading of more profitable mines. Already, restructuring is showing some results: after years of decline, Russia’s drop in coal production is leveling off, the level of subsidies is more manageable, and nearly half of the country’s coal now comes from privately-owned mines.

However, further restructuring is necessary, and implementation remains slow due to labor unrest and strikes in the coal industry, and even efficient mines in Russia are not without problems. Payment arrears have made it nearly impossible for mines to pay workers and purchase needed supplies and equipment. The country’s financial crisis of August 1998 exacerbated these problems, and the coal sector is still feeling the effects. Russia’s coal sector is likely to undergo further painful changes in coming years in its attempt to become more efficient and profitable.

Russia’s power generation and consumption have followed steady patterns of decline since the breakup of the Soviet Union. Power generation in Russia has dropped nearly 20% since 1992, from 964 billion kilowatt-hours (Bkwh) to 772 Bkwh, while electricity consumption has followed a similar downward trend, falling from 880 Bkwh in 1992 to only 703 Bkwh in 1998.

Russia has over 440 thermal and hydroelectric power stations, with a production capacity of 132 gigawatts (GW) and 44 GW, respectively. Total electric generation capacity in 1998 was 206 GW, down from 213 GW in 1992 but still enough production potential to supply Russian producers and the public with electricity, as well as meet the country’s obligation of export contracts.

However, the economic recovery since the August 1998 financial crisis has led to a slight increase in the country’s electricity consumption, taxing the country’s ability to meet this demand since much of Russia’s generating capacity is inefficient and obsolete by Western standards. A lack of investment in new generating and distribution capacity may mean that Russia could face power shortages within five years. A lack of fuel supplies at power stations has already led to periodic power outages, including severe power outages in the Russian Far East in the fall of 2000.

Russia’s electricity sector is controlled by UES, which is 52% owned by the Russian government. UES, headed by former privatization minister Anatoly Chubais, controls 70% of the country’s distribution system and oversees Russia’s 72 regional electricity companies. Chubais’ main priorities for UES include the abolition of payments arrears by customers, the introduction of competition in the production and wholesale electricity markets, and the pursuit of more rational pricing policies.

Russia’s electricity sector is in dire need of reform. Without significant investments and equipment upgrades, regional power shortages likely will become more widespread: in 1999 it was estimated that 49% of the power sector’s fixed assets were past their intended productive lives. Russian officials estimate that the country will need $6 billion-$11 billion annually from 2001 to 2005 to carry out maintenance and expansion plans, but UES has resources to invest just $1 billion per year. Efforts to restructure the sector to improve efficiency and attract much-needed capital have consistently failed.

Meanwhile, Gazprom continues to reduce gas supplies to the electricity sector. Natural gas is the main fuel used at Russian power stations, but supplies to power stations have shrunk by 50 billion cubic meters (Bcm) (1.77 Tcf) in the past 10 years, to 137 Bcm (4.84 Tcf) in 1999. In the fall of 2000, Gazprom notified UES that it would provide just 95 Bcm (3.35 Tcf) of gas for energy companies in 2001. Increased industrial demand for electricity also has forced power stations to operate at higher capacity, straining power companies’ ability to procure fuel supplies. At the same time, UES has begun to focus on electricity exports in order to boost its payments in hard currency and increase its cash flow.
Russia has nine operating nuclear plants and a total installed capacity of 21 GW, accounting for 13% of the country’s total generating electricity capacity. In 1998, the country’s nuclear power generation amounted to nearly 100 billion kilowatt-hours, and Russia plans to increase its use of nuclear power to meet its domestic electricity needs as it exports more natural gas to the West.

However, by 2001, four of Russia’s 29 nuclear plants will be 30 years or older, the maximum prescribed service life for a reactor, and by 2007, as many as 10 Soviet-era reactors will come to the end of their prescribed service life. Extending that service life has become a priority, but safety issues are an ongoing concern, especially with regard to the 16 relatively old reactors of the RBMK design used at Chernobyl. Older RBMK units at Kursk and St. Petersburg are to be overhauled and equipped with stopgap safety improvements to prolong their lives for another three decades.

In addition, Minatom, the government agency responsible for overseeing the country’s nuclear power plants, has complained that UES is not paying nuclear power plants in cash. UES announced plans to pay nuclear power plants only 65% in cash for electricity supplies in 2000, despite claims by Minatom that nuclear power plants need to receive no less than 70% of payments in cash to cover the cost of safe electricity production alone.

The lack of funding has forced Russia to focus on completing nuclear generating units already under construction rather than building new ones. The 1,000-MW Rostov 1 reactor is scheduled to be completed by end-2000, while the 1,000-MW Kalinin 3 and the 1,000-MW Kursk 5 reactors are nearly operational.

In October 2000, Russia announced it will market nuclear power plants to countries in Asia and Africa. The first of such plants, a $1.2-billion project for two 1,000-MW reactors, has been sold to India to be installed near the southern city of Chennai by 2008. Russia also reportedly is negotiating a similar deal with Iran. According to the International Atomic Energy Agency, reactors of Russian design would not be licensable in Western countries because they do not have all of the safety features that are mandatory, such as a containment dome.

B&M \ About Russia \ Energy