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Russia: How Much of a Reserve Tank?


Four months ago, when President George W. Bush met Vladimir V. Putin for the first time, he looked into the squinty blue eyes of the spymaster-turned-Russian president and said he "was able to get a sense of his soul." Now, in the wake of the terrorist attacks on America, the love fest between Russia and the U.S. is heating up. Putin immediately denounced the terrorists, said he would allow the U.S. to conduct humanitarian flights from Russia, and gave a nod to the stationing of U.S. troops in neighboring Uzbekistan, a former Soviet republic. And in a speech to German industrialists in Essen on Sept. 26, he made a surprising offer. "In case of regional conflicts breaking out, Russia is prepared to supply more oil," Putin said. "And I say this loud and clear."

No question, Russia can pump up production. In the past three years, oil companies have spent billions modernizing their facilities. This year Russia will produce 7 million barrels a day, 13% above 1999, and second only to Saudi Arabia, whose daily output is 8.4 million barrels. Russia could hike output by 4% next year, estimates United Financial Group, a Moscow brokerage. Some are even more optimistic. "Russian oil is a standby reserve," says Mikhail B. Khodorkovsky, CEO of Yukos Oil Co., Russia's second-biggest producer. "Russia could increase production by 10% to 15% a year easily."

That could substantially reduce the risk to the U.S. and Western Europe of a disruption in supplies from the Middle East--provided the oil can reach their markets. Russian exports are running at 2.8 million barrels per day this year, a 22% increase over 1998. But that remains nowhere near the 7.1 million barrels a day exported by Saudi Arabia. Though Russia could hike exports by 500,000 barrels a day by December, it would hit the limit of its pipeline system. That's too little to help the U.S. greatly in a sudden emergency. New pipelines on the drawings boards could up Russia's export capacity by 2.5 million barrels a day, but they won't be ready until 2004 or 2005. "There is a long way to go," admits Simon G. Kukes, president of Tyumen Oil Co.

Russia's size is the root of the problem. Most of the country's oil is produced in Western Siberia, thousands of miles away from ice-free ports that have oil-export capability. Oil must go by pipeline to Western Europe, or to tankers that can carry it to the U.S. or other markets. Transneft, the state pipeline monopoly, can export 3.3 million barrels a day, but it's carrying all it can. Many oil companies don't produce at full capacity since they can't get more pipeline space.

PIPELINE RACE. Even so, Russian producers are racing to boost drilling. Oil companies have tripled capital spending, to $6.5 billion since 1999. The Russian government is also doing its bit, by cutting rates on corporate profits from 35% to 24%.

More critical is the race to build new pipelines to ports in both Russia and its neighbors near the oil-rich Caspian Sea. Kazakhstan is expected to become one of the world's major oil producers in the next decade, and has received $10 billion in foreign investment since independence in late 1991. Azerbaijan, Uzbekistan, and Turkmenistan also have large reserves. "Central Asia will become a much more important region," says Daniel Yergin, chairman of Cambridge Energy Research Associates. "Certainly this new relationship between Russia and the U.S. will facilitate development of resources."

The first pipeline to transport Caspian oil overseas began operating on Oct. 15. The Caspian Pipeline Consortium, whose shareholders include ChevronTexaco, spent $2.5 billion on the pipeline, which stretches about 1,000 miles from western Kazakhstan across southern Russia to the Black Sea port of Novorossisk. Also in the works is one that would run from Azerbaijan across Georgia to the Mediterranean port of Ceyhan in Turkey.

Thousands of miles north, the first stage of the new Baltic Pipeline System will be done by yearend. Stretching from Russia's Timan-Pechora region to Primorsk on the Baltic Sea, it will add 240,000 export barrels a day. A number of oil majors, including Exxon Mobil Corp. (XOM), are exploring deposits off Russia's Sakhalin Island near Japan, where crude reserves estimates run more than 8 billion barrels. Japan is a natural market, but it's also a straight shot for tankers to the U.S. West Coast.

Still, it will be three to five years before major new amounts of Russian oil hit foreign markets. "I see Russia's oil production increasing, and as it does, I'm sure some of it will make its way to the U.S.," says Commerce Secretary Donald Evans, who was on an official trip to Russia last week. "It won't necessarily happen because of Afghanistan. It will happen because that's the way the market will work." But if Middle East oil is disrupted, Bush's new buddy Putin could make sure Russia sends as much oil as it can to the West--now. By Anna Raff in Moscow and Patricia Kranz in New York, with Christopher Palmeri in Los Angeles


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