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Russia: Boost In Oil Production Grabs World's Attention, But Can It Be Sustained?

According to just-released statistics from the Paris-based International Energy Agency, Russia has overtaken Saudi Arabia as the world's number one oil producer. What is behind Russia's return to the top and is Moscow's leadership in this all-important sector sustainable?

Prague, 26 March 2002 (RFE/RL) -- After years of falling production, last week's statistics showing that Russia bypassed Saudi Arabia as the world's leading oil producer -- at least for the month of February -- was headline-grabbing news.

According to figures supplied by the Paris-based International Energy Agency (IEA), Russia pumped 7.3 million barrels of oil per day last month compared to Saudi Arabia's 7.2 million barrels. The last time Moscow found itself in that position was in the 1980s.

What is behind the Russian surge and will the trend continue? Oil industry analysts say increased Russian production is primarily due to the use of more sophisticated technology at existing drill sites -- boosting yields, in some cases dramatically. But as Isabel Murray of the IEA tells RFE/RL, there are doubts about whether these temporary gains can be maintained.

"Technology improves every year, and there's more recovery in fields -- there's definitely a trend upwards all around the world. But is that going to be sustainable in the long run? You know, those fields only have so much oil in them."

Julian Lee is senior energy analyst at the London-based Centre for Global Energy Studies. He says that for Russia's increased production to be maintained in the medium and long term, there is no alternative to drilling new wells. He draws a parallel between Russia's current production increase and what occurred in the British oil industry several years ago.

"I think what we see happening in Russia is in some cases the application of some of the sorts of technology that we saw applied to North Sea fields in the mid-1990s. And what that tends to do is to dramatically increase the productivity rate of the wells themselves and the fields that these are applied to. But these gains in the North Sea certainly have been relatively short-lived -- maybe making a substantial impact for two to three years and then production beginning to decline again thereafter. So I think for the increase in Russian production to be sustainable, we need to see much more drilling in Russia. We need to see new fields developed and brought into production. At the moment, I think these increases have come largely from the reworking of old fields."

Lee disputes the production figures presented by the IEA and notes that despite undeniable increases in Russian oil production, ranking Moscow's output ahead of Saudi Arabia's is misleading.

"The problem is that the production figure for Saudi Arabia is for crude oil, whereas the production figure for Russia is for both crude oil and condensate. And condensate is the heavier liquid fraction that comes with the production of natural gas. Now, in addition to its 7.2 million barrels a day of crude, Saudi Arabia is currently producing something like 600,000 barrels a day of natural gas liquids and condensates. And in order to make a genuine comparison between Saudi Arabia and Russia, that needs to be added back into the Saudi production figure, which would take it up to about 7.8 or 7.9 million barrels a day. So Saudi Arabia, on a truly comparable basis, is still producing more than Russia."

Numbers aside, the important issue is the direction that Russia's oil industry will take over the next few years. Oil and gas account for 40 percent of Russia's exports and 13 percent of the nation's gross domestic product, making the continued growth of the sector vital to Russia's economy.

Isabel Murray of the IEA says the financial crisis in Russia in 1998 played a big role in today's production boosts -- by making it much cheaper, especially for foreign companies working in Russia, to invest in better drilling equipment. But little has been done to create a stable business climate that will attract the outside investment needed to effectively develop Russia's oil industry over the long term.

"After the crisis in '98 -- August '98, the financial crisis -- the ruble devalued about four times, and most of the costs of oil companies in Russia are ruble-based. So that really stimulated a lot in terms of reducing costs without really much effort. I think before that, though, during the time when oil prices were quite low, in the early 1998 period, lots of oil companies were really trying to streamline costs and that was a very positive exercise, I think, in terms of the need to reduce costs. Then the ruble devaluation made a huge bonus for all the oil companies and reduced costs dramatically, so Russia, all of a sudden, looks very attractive in terms of ruble-based costs. But you also need, I think, for more capital-intensive projects, you need a stable investment environment. It's not just these one-off blips of ruble devaluation that's going to bring in the long-term investors. You need something that's going to be a guarantee over the life of the project -- and those are 10-, 20-year projects."

Investment will also have to go into expanding Russia's export capability, as Moscow currently exports less than half of the oil it produces -- partially due to the limited capacity offered by the state pipeline monopoly Transneft.

Julian Lee of the Centre for Global Energy Studies says changes to Russia's tax legislation will be necessary to allow current production-sharing laws to go into effect and attract more foreign investment.

A production-sharing agreement -- or PSA, as it is known in the industry -- allows an oil company to develop fields and produce oil according to detailed arrangements agreed between the oil company and the host government. Some of the oil production is taken as royalty by the government, some is classified as "cost-recovery oil" and taken by the oil company to recover its costs, and the balance is classified as "profit oil" and divided between the host government and the oil company on an agreed basis.

"If we are going to see substantial foreign investment in Russia, in the oil industry, then I think we do need some changes to the tax laws. We have the production-sharing law that has been in place for some years now, but the enabling legislation that brings other tax laws into line with the PSAs has not yet gone through. And I think that has been a barrier to Western investment. But I think, equally, the attitude of the Russian oil industry itself, which I think is still not yet convinced that its wants foreign investment, is something that is also going to have to be overcome."

The increased attention shown to Russia by members of the OPEC oil-exporting cartel is evidence of Moscow's resurgent importance on world markets. OPEC expended much effort to woo Moscow into announcing temporary curbs of 150,000 barrels per day on crude exports.

If Russia plays its cards right, it will been in a position in future years to strengthen its negotiating position in relation to the cartel.