Newspaper article on gas prices

Fiona Hill is a fellow in the Foreign Policy Studies Program at the Brookings Institution, in Washington, D.C. Florence Fee is the CEO of F. C. Fee International, a private energy consulting company based in London.

Following the terrorist attacks against the United States on 11 September 2001, growing tensions in American relations with Middle East states coincided with the efforts of the Organization of Petroleum-Exporting Countries (OPEC) to impose production cuts to shore up petroleum prices. U.S. plans to overthrow Saddam Hussein's regime in Iraq, the worsening crisis in Israel and Palestine, a backlash in Saudi Arabia against long-term U.S. military presence, and the possibility that it would become the staging ground for an attack on Iraq all led to questions in Washington, D.C., about the wisdom of continuing to rely on Middle East oil. Discussions of possible alternatives threw the spotlight on Russia, along with other oil-producing areas in the Caspian Basin and West Africa.

Since 1998, Russia's oil industry has experienced a significant revival after a cataclysmic collapse in output in the 1990s. Some of its oil companies have achieved significant production increases, produced ambitious plans to break into new energy markets, expanded into international upstream and downstream operations, and launched a public relations offensive to present themselves as players in the global economy. 1 Against this backdrop, Russia, which is not a member of OPEC, mounted a fierce public resistance to the organization's demands that it cut its production and exports. Ultimately, in December 2001, Moscow agreed to a token export reduction of 150,000 barrels per day for the winter quarter. That reflected normal seasonal cuts implemented by Russian oil companies operating in the extreme cold of Siberia and bottled in by winter port restrictions. Moscow's snub to OPEC was obvious.

Russia suddenly became one of the new great hopes of Western efforts to diversify U.S. and world oil supplies beyond the Middle East and Persian Gulf. As American energy secretary Spencer Abraham noted during a November 2001 visit to Moscow, Russia seemed to be "emerging as a separate nucleus of the energy equation." 2 In the Washington Post in December 2001, David Ignatius asserted that "Moscow is on its way to becoming the next Houston--the global capital of energy." 3 By January 2002, Russia's President Putin had been hailed by a Canadian newspaper as the "world's new oil Czar," 4 and the Russian media was replete with commentary on Russia's role as the new power broker in international energy markets. In an extended article in the March/April 2002 issue of the preeminent American journal Foreign Affairs, two energy analysts went so far as to suggest that Russia--together with the energy-rich states of the former Soviet Union clustered around the Caspian Basin (Azerbaijan, Kazakhstan, Turkmenistan, and Uzbekistan)--was poised to challenge Saudi Arabia for global energy dominance. Russia, they argued, could soon displace Saudi Arabia and OPEC in oil markets in the United States, Europe, and Asia. 5 The authors, along with media commentators, saw increases in Russian oil production and new reserve finds in the Caspian Basin as evidence of substantial future export capacity. In addition, they depicted the Russian energy industry as an independent actor, emancipated from state control (unlike the state-held oil companies of OPEC members), which was eager to help the United States and the West break free from OPEC dependency by becoming a reliable, long-term energy partner.

Certainly, the Soviet Union was a major international energy player in the 1980s, and Russia has assumed much of that mantle since its dissolution, but in 2002 Russia's grip on the attention of the media and international energy analysts is due more to a confluence of events and circumstance than a serious assessment of the country's energy capabilities. In most discussions of Russian energy, the extent of Russian oil production capacity is not questioned. Differences between Russian gas and oil assets are not distinguished. Little distinction is made between Russian energy and that of other Caspian Basin states, and the relationship between the Russian energy industry and the state is not questioned. The idea that Russian energy can take on Saudi Arabia and OPEC has become a cherished media myth, despite even the protestations to the contrary of Russian industry figures such as YUKOS chairman and CEO Mikhail Khodorkovsky. 6

Countering the Myths of Russian Energy Capabilities

As a counterpoint to those discussions--on the combined basis of a decade of research on Russian and Caspian energy issues, many years of on-the-ground experience in the oil industry in Kazakhstan and Russia, 7 and numerous personal interviews with members of the Russian energy sector--in this article we review recent developments in Russia's oil industry. We offer an analysis of the evolution and current state of Russia's energy sector, the challenges that Russia faces in expanding its reach into global energy markets over the next two decades, and an assessment of the prospects for Western investment in the Russian oil and gas industry.

Although Russia does have the potential to break into some specific global energy markets as a supplemental supplier to unstable states in the Persian Gulf, it cannot displace the Middle East as the world's primary supplier of oil, either in the near term or the long term. Even if Russia's oil production can be increased, its oil reserves are considerably smaller than those of the key countries of Saudi Arabia, Iraq, Kuwait, the United Arab Emirates, and Iran. However, Russia is to gas what Saudi Arabia is to oil. Over the next decade, continued crises in the Middle East and increasing concerns about pollution and global climate change will inevitably focus attention on Russia's vast reserves of cheaper, cleaner natural gas.

Securing reliable, high-growth twenty-first-century markets for its pipeline gas and liquefied natural gas is among Russia's top priorities. But success in international gas markets will not come easily in spite of Russia's potential. It can only be assured through major increases in Russia's current production, significant international as well as Russian investments in infrastructure, and the timely development of fully functioning gas markets in Asia. The development of Russia's own economy will also have an effect on its gas production. Over the last decade, gas has been the main source of value to subsidize and sustain the vast portion of Russia's economy that it inherited from the Soviet Union, which has been unable to make the transition to a market economy environment. In the absence of major structural changes in the economy, the demands on the gas industry will continue to increase, impinging on its ability to improve efficiency and boost exports.

Energy is also one of the few strategic assets that Russia has left after the collapse of the Soviet Union. As players in the world economy, Russia's oil and gas corporations give Russia a voice in the outside world, especially in Russia's immediate region and in Europe. Over the last two years, following a period of privatization in the 1990s, the Russian government has gradually and steadily increased its ties with and influence over Russian energy companies, effecting, in essence, a creeping renationalization of the sector. Energy, and energy companies, are important tools for the state in promoting Russian foreign policy. That fact, and the vital importance of oil and gas to the domestic economy, may not augur well for the future of foreign investment in the industry.

Petrodollars and the Russian Economy

Both oil and gas have been the mainstays of the Soviet and now Russian economy for decades. Indeed, a direct correlation can be made between oil prices and government revenues. In 1981, after the 1970s OPEC oil embargoes sent oil prices to as high as $39 a barrel, the USSR became the world's largest oil producer, with the bulk of its production exported for hard currency. 8 World oil price declines later in the 1980s struck a major blow to the Soviet economy. From 1999 to 2001, Russia experienced the reverse fate: an economic bonanza, as oil prices increased from around $10 a barrel in December 1998 to a peak of around $33 a barrel in September 2000. 9

Oil and gas account for nearly a quarter of Russian GDP, about half of its export earnings, and around a third of government tax revenues. Every dollar increase in the world market price of a barrel of petroleum translates into as much as $1.5 billion of additional yearly budget revenues. 10 Thanks in large part to high oil prices, at the end of 2001 the Russian economy experienced a major boom, which replenished state coffers and enabled the government to balance its budget, pay wages and pensions, and meet its international debt repayment obligations.