Oil of Russia

The Thorny Path to a Market Economy

On the evening of December 25, 1991, USSR President Gorbachëv appeared on Soviet television screens and read a strange statement, ending with the words, “In view of the emerging situation with the formation of the Commonwealth of Independent States, I terminate my activity as president of the USSR. I make this decision based on principled considerations.” After these words, the red flag was lowered from the flagpole on the main building in the Kremlin and the superpower that was the USSR de jure ceased to exist.

On that day, the former Soviet leader merely stated a fait accompli, because two weeks earlier, at a meeting in the Bialowieza Forest on December 8, 1991, Boris Yeltsin of Russia, Leonid Kravchuk of Ukraine, and Stanislaw Shushkevich of Belarus had loudly proclaimed the formation of a new entity throughout Soviet territory, the Commonwealth of Independent States (CIS), and stated that “the Soviet Union no longer exists.”

From the first days of 1992, the Russian Federation government was faced with the grave consequences of the severe systemic economic and sociopolitical crisis caused by the disruption of economic relations throughout the production chain and the collapse of the financial system, which had struck a serious blow against the Soviet oil and gas industry. A sharp drop in the standard of living, caused by the depreciation of State Savings Bank deposits and business payment delinquencies, was accompanied by failures in the real sector of the economy, which had been inherited from prior years. Furthermore, serious new problems were added to severe economic distortions: chronic lagging of agriculture, light industry, and the food industry, an underdeveloped public service sector and overdevelopment of the military-industrial complex and heavy industry.

The subsequent necessary process of breaking down the command-administrative system and transitioning to the development of a market economy forced the leaders of the new Russia to implement a comprehensive series of critical political, social, and economic transformations. The difficulty of accomplishing this task was formidable, since the USSR’s economy had been shaped and operated for seven decades as a “unified economic system,” that is, as a single structure with rigid internal division of labor, highly concentrated and narrowly specialized production, and specific technological ties between enterprises regardless of their geographic locations.

The USSR’s radical transition to a market economy in the early 1990s began in the context of a catastrophic failure of the administrative mechanism of mandating resource allocations and the resulting complete exhaustion of its ability to continue functioning. The Russian economy had become a complex and unstable system characterized both by an unexpected change in the nature of macroeconomic and microeconomic processes and by a drastic change in the makeup of the factors determining the dynamics and intensities of these phenomena.

During that period, this author worked as USSR first deputy minister of the oil industry, and clearly saw that our industry was under pressure from highly complex problems, including disruption of economic relations, geometric growth in delinquencies, unsupportable burdens of taxes and financing costs, a sharp drop in investments, the appearance and wide prevalence of barter deals, and much more. As professional oilmen, we tried to save the situation, but this proved extremely difficult.

The mechanical, cookie-cutter implementation of theoretical postulates from the Chicago school of economics by members of the young reformers’ government headed by Yegor Gaydar, and especially Minister of Fuel and Energy Vladimir Lopukhin, led to the adoption of many contradictory and unjustified financial and administrative decisions for regulating the Russian oil and gas industry. These decisions were largely responsible for the subsequent acute crises in the industry, and most importantly, helped consolidate and promote the “law of the jungle” among entrepreneurs as a unique principle of economic behavior.

As a result, according to a report by the International Monetary Fund (IMF), Russia’s real gross domestic product shrank 19% in 1992, and another 12% in 1993. By mid-1994, Russia’s total production volume had shrunk by more than half since 1989.

Beginning in 1992, Russia’s oil and natural gas production began to fall due to the overall reduction in the country’s industrial production and the snowballing of negative phenomena in the industry. A number of critical problems became distinctly apparent: major high-flow production fields that constituted the core of the resource base had largely been depleted; newly-added reserves had sharply declined in quality; funding of geologic exploration had been cut; high-performance technology and equipment for production and drilling were in extremely short supply (most of the hardware was more than 50% depreciated, and 70% of the drilling rigs were obsolete and required replacement); the industry’s material, equipment, and financial support had seriously deteriorated; and the shortage of efficient and “green” equipment created an especially acute problem of environmental pollution. That year, the structure of the Russian oil and gas industry comprised nearly 2,000 uncoordinated associations, enterprises, and organizations belonging to the former Soviet industry ministry.

Under these difficult conditions, the Russian government was forced to begin a radical reorganization of the oil industry, inasmuch as it was critical to provide export revenue from the sale of oil, which would support urgent demands for the function of the nation’s economy in the transition period.

The reformers initially considered plans for resuscitating several powerful state-owned oil companies within the public economic system. The idea was, essentially, to create some modernized entities borrowed from the previous Soviet economy, adding the elements of a certain financial independence and cost accounting for enterprises.

An alternative program was developed in the oil industry community by this author’s colleagues and like-minded people. We came to the conclusion that a radical change was necessary in the approach to oil industry problems (which had never been addressed coherently by the former Soviet government). Under the Soviet system, one ministry was responsible for oil production, another for refining, and a third for petroleum products distribution. In our opinion, the experience of Western oil companies, which combined enterprises of the entire process chain “from the well to the gas pump,” should be implemented. In other words, we proposed a strategic course for the creation of major industry corporations. This form of business activity, different and separate from the particular individuals who own it, is acknowledged throughout the world as the most efficient way of organizing enterprise and financial capital. The unique form of financing inherent in corporations, namely the sale of stocks and bonds, can in principle (given a reasonable business organization) overcome the main problem that Russia’s fuel and energy industry was facing at the time—a near-total lack of investment. This view was supported by many other heads of Russian oil production enterprises, and ultimately formed the basis for later development of the concept of organizational changes and privatization of the industry’s enterprises and organizations.

That same year, the Russian Ministry of Fuel and Energy drafted a concept for organizational changes and privatization of enterprises in the fuel and energy industry, which was based on the following principles: formation of big oil and petroleum products market businesses in the form of vertically integrated oil companies (VIOCs), which would be financially stable and competitive on domestic and foreign markets; preservation of unified process and production complexes for oil production and refining and petroleum products sale; creation of a competitive environment for enterprises performing service functions and for the production infrastructure; state control of industry enterprises during the transition period, provided through direct state capital investment in joint-stock companies; preservation of the integrated trunk pipeline system, with guarantees of free (nondiscriminatory) access for all crude oil and petroleum products producers; procurement of additional funding sources for production through privatization, upgrade of existing production capacity, and construction of new production capacity; and balance between the interests of the federal center and regional authorities. It should be noted that the privatization concept was an attempt to join two incompatible approaches, the first of which put the interests of the work forces at privatized enterprises first, and the second of which prioritized the objectives of public privatization and adherence to the principle of social justice in the distribution of state property.

President Yeltsin initiated the industry’s privatization process by Decree 1403 of November 17, 1992, “On Features of Privatization of State Enterprises, Production Associations, and Scientific Production Associations in the Oil and Refining Industry and Petroleum Products Supply and Conversion of These Entities to Joint-Stock Companies.” In this decree, oil-industry enterprises subject to privatization under the decree were divided into three groups.

The first group included oil and gas production associations, which were privatized as a unified process complex. Thirty-eight percent interests in these joint-stock companies were restricted to federal ownership for three years and assigned to the state enterprise Rosneft for administration.

The second group included the companies LUKOIL, Yukos, and Surgutneftegaz. The structure of these three companies was defined by a subsequent Russian Federation Council of Ministers decision dated April 22, 1993. These companies included five Tyumen oil production associations, five major refining complexes, and 18 specialized petroleum products supply organizations in the central and northwestern regions, Volga region, and Urals.

According to the charter documents, the oil companies’ authorized capital was a 38% stock interest in their subsidiaries. Controlling (49%) interests in the companies themselves were restricted to federal ownership for three years. Twenty-five percent of the stock in each newly-formed joint-stock company was preferred, and common stock was not subject to conversion on subsequent resale. All shares restricted to federal ownership for a particular term were voting shares. Moreover, 40% of the oil company stock was subject to sale at investment auctions for two years on terms set jointly by the Russian Federation State Committee for State Property Management and the Ministry of Fuel and Energy. In addition, foreign investors could not own more than a 15% share of a company’s stock.

Management teams for the vertically integrated oil companies were approved by the Russian Federation government. Clearly, the state intended to retain rigid control over the operations of these companies for a certain period.

The third group included companies involved in the transportation of crude oil and petroleum products: Transneft and Transnefteprodukt. Forty-nine percent interests in these companies were restricted to federal ownership for three years.

Several characteristic features of the initial phase (1991–1995) of industry privatization can be identified. The first was the priority given to the political aims of the privatization process and the concomitant ultra-high rate at which it was carried out. The second was the primarily formal nature of privatization (whereby major enterprises were sold for stock) and the low profitability of privatization. And the third was the introduction of a system of privatization vouchers.

Unlike privatization with a developed market economy, the privatization process in Russia and in Eastern Europe encountered a series of obstacles. First of all, the scale of the anticipated transformations was not comparable to similar processes in countries with market economies. There was practically no capital market infrastructure. A sharp drop in production considerably complicated the assessment of the potential of low-profit enterprises. Furthermore, the population was short of funds. These conditions explain the inevitable imbalance between the sale of state property and the need to establish privileges for various population groups (labor, retirees, the unemployed, etc.).

Nevertheless, the radical transformations carried out in the domestic oil and gas industry, which were part of the overall transformation of the Russian economy, are today a shining example of a successful and coherent reform of a key industry in post-Soviet Russia.

As a result of the first phase of privatization, 14 large vertically integrated oil companies, as well as Gazprom Russian Joint-Stock Company and another 250 so-called “independent” companies, all competing with one another, engaged in the production of crude oil and petroleum products in the mid-1990s. The second important phase was the further consolidation of the industry, when the vertically integrated oil companies LUKOIL, Surgutneftegaz, Yukos, Sibneft, Tyumen Oil Company (TNK), Sidanco, Tatneft, Bashneft, etc. were formed, which privatized other significant production and refining assets.

President Yeltsin accelerated the vertical integration of privatized companies by a decree dated April 1, 1995, which permitted the incorporation of subdivisions into vertically integrated companies through stock swaps. The subsequent efficient operations of vertically integrated companies during the third phase of the industry’s reform, when these companies gained the capacity to independently formulate and implement strategic and tactical market objectives, did much to reverse the alarming trend of sharp decline in oil and natural gas production in the country.

Unlike major Western oil companies, whose vertical integration in the 1960s crossed national boundaries, the Russian VIOCs were created instantly, pursuant to presidential and governmental regulations of the 1990s, at a time when the ambient environment in the global oil business was qualitatively very different and, accordingly, presented more complex problems along the path of its development. In the last decade of the 20th century, the international economic system was entering an age of globalization that encompassed the oil sector as well, so that global oil megacorporations appeared and began to play a leading role in the industry.

However, the Russian oil companies lacked the time to pass through the logical phases for developing vertical integration and gaining the experience to operate in a competitive environment, and so the unsolved problems that had festered since the time of centralized economy, together with the errors committed in the course of privatization, consolidation of assets, and formation of company corporate structures acted as brakes on the path to the development of a major oil business in Russia and its integration into the international oil business. Furthermore, this process occurred under economic conditions that posed a challenge for Russian oil business development, namely, a deteriorating macroeconomic situation associated with a transition to market conditions with an obsolescent business structure, excess capacity, decrepit fixed assets, and falling production due to declining demand for crude oil and petroleum products within the country. Moreover, there was uncertainty during this period regarding how strong a role the state would permit market forces to play.

Nevertheless, it was the market system of control that pulled the oil industry out of the crisis. The industry passed its “strength test” in 1998, when world oil prices fell to $9 a barrel. In that situation, the Russian companies not only did not cut production, but did not freeze their investment programs either. Moreover, the price crisis spurred an explosive growth in production and financial indicators. It forced the companies to sharply increase the efficiency of their operations by cutting costs, expanding sales, and improving the quality of their finished products. The first results of the business restructuring, backed by the favorable price situation of recent years, created a unique opportunity for the Russian oil companies to enter the international capital market. The capabilities of national companies to invest funds in the exploration and development of Russian fields, the production of quality motor fuel, the construction of transportation infrastructure, and the provision of environmental safety also grew.

Thus, with the beginning of the new century, the Russian oil and gas industry became a unique powerful engine for Russian economic growth. Whereas Russia produced 356.4 million tons of crude in 2000, it produced 541.7 million tons in 2006. The efficient operation of Russian vertically integrated oil companies, which now produce 88% of the country’s crude oil and petroleum products and control the entire chain of oil production, was a principal result of the organizational restructuring of the Russian oil industry during the transition to a market economy. And not only did the nature and essence of relations among businesses change radically, but a certain specific system of relations between businesses, lawmakers, and government agencies emerged. The political factor has always had a strong influence on the operation of Russian oil and gas companies. Clearly, this influence will continue in the future, and not only because of the industry’s huge role in ensuring the socioeconomic stability of Russian society, but also because it is rooted in the very history of the formation of major oil companies in Russia.

With the completion of the organizational phase of Russian VIOC formation, VIOC management faced the question of choosing an effective strategy that would support competitive positions both in Russia and abroad. Incidentally, for a long time, the stated goals of Russian oil companies have not provided a clear idea of their chosen strategies, which is a reflection, on the one hand, of their management’s lack of clear ideas on the matter, and on the other hand, of the extreme vagueness of the development goals of their ambient environment. However, the Russian oil companies proceeded to formulate their goals anyway, and these are no different from the strategic goals of leading Western energy corporations, despite their different levels of development and scales of operation.

On the whole, despite the difficult set of problems inherited from the Soviet period, Russia has now managed to create the basis for a new economic system, including a whole series of imperfect, yet still functional market institutions such as private property, convertible currency, a tax system, labor law corresponding to market realities, an elaborate banking system, a securities market regulatory system, and natural monopolies.

In the first decade of the 21st century, all of this has permitted the Russian oil and gas industry, and the entire national economy, to recover fully from the crisis, stabilize the country’s financial and foreign trade position, establish stable positive structural shifts in industrial production, and make the transition to sustainable economic growth, providing a steady improvement in the Russian standard of living. According to a World Bank estimate, the oil and gas industry’s contribution to Russia’s GDP is currently on the order of 25%, with this key industry providing one-third of the nation’s industrial production and generating about one-third of all revenue to the Russian Federation consolidated budget and about half the federal budget’s revenue from exports and hard-currency income.

The Key to the Treasury of “Black Gold”

The history of our civilization’s development has made oil one of the main symbols of the industrial era, and perhaps of the entire 20th century. The change in eras that arrived at the turn of the century, marking the beginning of the “information society,” not only failed to reduce the value and importance of “black gold” in the world economy, but on the contrary, raised it to new heights. Moreover, the ever-growing demand for crude hydrocarbons has been forcing scientists and specialists to turn more and more frequently to analyses of remaining crude hydrocarbon reserves. And increasingly, we hear forecasts that global oil reserves are nearing exhaustion.

In late 2007, the documentary film A Crude Awakening: The Oil Crash, directed by Basil Gelpke and Ray McCormack, hit the screens of leading Western countries. The film presented a futuristic picture of the world to come after petroleum resources are exhausted, portraying “how our civilization’s dependence on oil is colliding with geology.” The filmmakers are certain that global oil production has peaked, and a sharp decline will inevitably follow, creating serious problems for our whole civilization.

This view is shared by Zapata George, a leading Western analyst of the energy industry. His website contains a page with the alarming title “Oil Shortage Now!” It is truly an alarming article to read. According to George, our planet passed the peak of traditional oil production in 2005, and the world economy now consumes over 86 million barrels of oil a day, even though it produces less than 85 million barrels. Global oil reserves are declining at about 20 million barrels per month. He predicts a steady rise in the price of oil, which will cause serious problems in the global economy.

We should note that the theory of peak oil production is not new at all, and the earliest version of this point of view dates to the mid-20th century. Its originator, the American geophysicist King Hubbert, predicted in 1956 that peak production in the southern states of the US would occur around 1970, and he was actually proved right. However, his followers tend to forget that he also predicted a global production peak in 1990, which did not happen. Thus, the theory still has many supporters and critics. These include both moderates and radicals, who assert that oil production has not only reached its peak, but has passed it.

The international mass media have had much to say on the subject in the form of various judgments of Russia’s approach to the “twilight of the oil epoch,” that is, a critical situation with “black gold” reserves in Russian territory. Then again, the first pessimistic forecasts of the approaching exhaustion of Russia’s oil reserves appeared in the late 19th century, and the foreign skeptics of the time received a convincing rebuttal from the great Russian scientist Dmitry Mendeleyev, who sent a letter on August 27, 1889 titled “On the Resumption of Rumors of Baku Oil Depletion” to Ludwig Mond, president of the Society of the Chemical Industry in London, and to William Anderson, a department chairman at the British Association for the Advancement of Science, in which he stressed, “The revival of rumors regarding the coming depletion is based partly on a complete unfamiliarity with the phenomena of oil depletion..., and partly on a game of intrigue that spreads rumors for its own purposes.”

In the 20th century, the same story was repeated at regular intervals with “expert estimates” made by foreign analysts of the coming exhaustion of Soviet, and later Russian oil. However, these false prophecies were left in ruins by the discovery and development of hydrocarbon resources at the “Second Baku” in the Volga-Urals province, followed by the exploitation of the vast potential of the Western Siberian oil and gas province.

Unfortunately, similar pronouncements can still be heard today. In December 2007, the ranks of “oil pessimists” were joined by the German Institute for Economic Research, whose analysts doubt Russia’s ability to meet the world’s growing demand for oil and gas. According to the Institute’s estimates, Russia accounts for 29% of the European Union’s oil imports and a third of its gas imports, but “Russia’s existing oil and gas reserves will run out in a decade if their production continues at present rates.”¹ The German experts’ report states: “Despite the fact that Russia is the world’s second largest oil producer, it is only seventh in explored reserves. At the present level of production, these reserves will be exhausted in approximately 22 years.”² The study’s authors claim, “The fact that Russian exports are growing less quickly than provided by its energy strategy does not affect delivery of fuels to Europe over the short and medium term. However, over the long term, shortages could still arise because Europe will be competing with other potential consumers, such as China.”³ In the opinion of these analysts, Russia will experience the anticipated problems with fuels, primarily due to inadequate investment in the energy sector, while foreign capital investments are impeded by “inadequate political conditions.”

These pessimistic forecasts can and must be opposed, first of all, by the hard facts, which are stubborn things, as everyone knows. According to the estimate of noted scientist Nikolay Laverov, vice president of the Russian Academy of Sciences, Russia’s developed oil reserves total only 16% of those available, and its developed natural gas reserves are only 5%, so a shortage of crude hydrocarbons does not pose a threat to the country at all in the present century. To date, some 3,200 oil and gas fields have been discovered in the Russian Federation, of which only 1,600 are now in development. The other 1,600 have never been developed by anyone, nor have licenses even been issued for their development.

Speaking at a Russian Federation government meeting, Minister of Natural Resources and Ecology Yury Trutnev noted that federal budget investments in geologic exploration had quadrupled from 2004 to 2009, and mineral licensees had quintupled their spending on geologic exploration. In 2005–2007 alone, the country discovered 194 oil and gas fields. In the record year of 2007, 44 oil and gas fields were discovered, two of these in Eastern Siberia. Thus, 606 million tons of oil were explored, or 20% more than were produced. Moreover, 23 trillion cubic feet (TCF) of natural gas were explored, which is also in excess of production. In addition, the state’s annual income from mineral development parcel auctions in the period just ended [2009] has doubled to some 40 billion rubles.

Trutnev also noted that the overall growth of Russian hydrocarbon resources in 2007 alone totaled 7.4 billion tons of coal equivalent (TCE), or 2.4 times more than in 2004, when this indicator stood at 3.1 billion tons. The growth in Category C₁⁴ oil reserves just on the Yamal Peninsula was 64 million tons, double the 2006 figure, and gas reserves increased there by 9.8 TCF, 26% more than the prior year. Mineral license income to the state increased 12-fold, and mineral production taxes increased sixfold. Expanded replacement of reserves for the most important types of minerals was assured. Despite the present financial crisis, the Ministry of Natural Resources and Ecology managed to defend the funding of subsurface geologic studies necessary to sustain growth rates in 2010.

The future plans of the Russian Ministry of Natural Resources and Ecology include obtaining geologic, geophysical, and geochemical information on areas of the country totaling 2.3 million square miles in size, while the area covered by a hydrogeologic and engineering geologic study will total nearly 386,000 square miles. Updating of the geologic baseline using modern research methods will improve the accuracy of studies and the efficiency of geologic exploration.

Since hydrocarbons will be the dominant fuel in coming decades, there is an objective need to intensify geologic study and then involve Russia’s new major oil and gas provinces in development. For this reason, the Russian government has paid special attention to the following important issues in the course of discussions on replacing the country’s crude mineral baseline: improving mechanisms for attracting investments to mineral extraction; stimulating the use of resource-saving technologies and comprehensive use of crude minerals; ensuring the efficient use of funds allocated from the federal budget for subsurface geologic studies and replacement of the crude mineral baseline (including via state procurement of associated activities); linking measures to replace mineral resource reserves with prospects for development of regions and branches of the economy; supporting human resources for geologic exploration; improving geologic environmental monitoring and forecasting of hazardous geologic processes, including earthquakes; and studying the financial and economic feasibility of the proposed steps.

The largest area of promise for such activities is the geologic study of the country’s continental shelf. It is in the offshore areas under Russian Federation jurisdiction that the discovery of large and unique crude hydrocarbon fields is considered most likely.

Experience developing the Western Siberian oil and gas province has shown that preparing each new oil-producing region is a long process. Assuming that the geologic study of offshore subsurface resources is intensified quickly, production of crude hydrocarbons on the continental shelf could reach 20% of total crude hydrocarbons produced in the Russian Federation by 2020. The exploitation of offshore subsurface resources will produce a large multiplier effect through the development of related industries, primarily the high-technology areas of machine building and transportation, and will help resolve important issues of energy supply and local employment.

The Russian Federation’s continental shelf has an area of 2.4 million square miles. About 1.5 million square miles show promise for oil and gas exploration. Recoverable hydrocarbon resources on the Russian Federation’s continental shelf total about 110 billion tons, including over 14.9 billion tons of oil and about 2,578 TCF of gas.

The bulk of the resources (about 66.5%) lie under Arctic shelves (in the Barents and Kara Seas). The degree of exploration of offshore hydrocarbon resources is low, and does not exceed 9–12% in most areas. The area of Russia’s expanded continental shelf in the Arctic, beyond the 200-mile limit, could amount to 463,000 square miles, with an inferred hydrocarbon resource potential of 5.4 billion TCE.

So far, more than 20 large promising oil and gas basins have been identified on the Russian shelf, and 36 fields have been discovered, including unique gas fields (Shtokman, Rusanovo, Leningrad) in the Western Arctic and several large oil fields on the northeast shelf of Sakhalin. Moreover, offshore continuations of more than 10 oil and gas fields previously discovered on land have been found.

In December 2007, an office of Gazprom’s Scientific and Technical Council and the Coordinating Council for Scientific Research of the Russian Academy of Sciences (RAS) discussed a draft “Program for the Comprehensive Development of Fields on the Yamal Peninsula and in Adjacent Waters.” The draft reflected new technologies and technical solutions in the validation of the crude mineral baseline and the geologic exploration, development, and surface construction of fields, the transportation of gas and liquid hydrocarbons from the peninsula, and the refining of liquid hydrocarbons. Special attention was devoted to the environmental component, as the problem of minimizing human impact on the environment is a top priority. In particular, the draft specified the development of processes and special measures to minimize the adverse impact on the troposphere and surrounding territory and the use of closed-loop water-supply systems to prevent surface-water pollution.

One priority of Russian geologists is the discovery of hydrocarbon resources that will subsequently fill the Eastern Siberia–Pacific Ocean trunk oil pipeline. Stratigraphic drilling is proposed to be done in the Krasnoyarsk Territory, Evenk District, of the Sakha Republic (Yakutia), and the Irkutsk Region. In all, seven wells or 79,000 linear feet of hole are to be drilled in just three years.

The Vankor oil and gas field is of particular importance for the economy of Eastern Siberia. In 2007, the growth in recoverable oil reserves at the Vankor field was 200 million tons, and the field’s total reserves increased 28 million tons, to 567 million tons. Thus, in terms of oil reserves, the field can be classified as unique. The oil reserve growth constitutes 53% of the total reserve growth for Rosneft.

At present, geologic study is under way within the Yurubchen block of the Yurubchen-Tokhomo oil and gas field, as along with exploration of the Agalya gas condensate field. The Yurubchen block is located in the Baykit District of the Evenk Autonomous District, 93 miles southeast of the town of Baykit. As of January 1, 2005, Category C₁ and C₂ recoverable crude hydrocarbon reserves in these fields amounted to 82.2 million tons and 262 million tons of oil and gas condensate, respectively, as well as 4.5 TCF and 14.4 TCF of gas.

Chayanda field, one of the main fields in Yakutia, contains 44.5 TCF of natural gas reserves. But since its confirmed reserves are only 13.4 TCF, it requires additional exploration. The principal difficulties here stem from the need to exploit oil and gas fields under difficult climatic and mining geologic conditions, where qualitatively new levels of industrial and environmental safety must be assured for exploration and development.

Overall, the extensive lands of Eastern Siberia—from Turukhansk to the Taymyr—exhibited reserve growth of 130 million tons of oil and 1.9 TCF of gas in 2009 alone. Russian geologists continue to work actively, and funding levels for their work match those of the last two years.

Eastern Siberia is expected to become the main resource base for filling the Eastern Siberia–Pacific Ocean (ESPO) pipeline, and special attention is being devoted here to the Talakan, Vankor, and Upper Chona fields. The route of the 2,920-mile long ESPO trunk oil pipeline passes through Tayshet and Ust-Kut, in the Irkutsk Region; Lensk and Aldan, in Yakutia; Skovorodino, in the Amur Region; and Kozmino Bight, in the Maritime Territory.

Construction of the ESPO pipeline began on April 28, 2006. The length of the first stage, from Tayshet to Skovorodino, in the Amur Region, is 1,674 miles. The first oil was pumped into the Eastern Siberia–Pacific Ocean trunk oil pipeline in early April 2008. Near the city of Tayshet, Irkutsk Region, the first completed segment of the Eastern oil pipeline, from the zero mark to mile 148, was tied into the existing Transneft pipeline system and the trunk pipeline began to fill with oil. The beginning of the segment is the tie-in point to the existing Omsk–Irkutsk and Krasnoyarsk–Irkutsk oil pipelines, and the end point is defined as the pig launching unit at Vikhorevka, Irkutsk Region. Construction of most ESPO pipeline linear facilities was completed in 2009, and late that same year, the Kozmino oil terminal near the city of Nakhodka, the terminal point of the Eastern Siberia–Pacific Ocean pipeline system, was brought online. In November 2009, the first tanker dropped anchor at the new maritime port for loading. During the first phase, the port will receive 33 million tons of crude per year, and there is a real possibility that its capacity will be increased to 55 million tons.

Further development of the ESPO pipeline calls for increasing capacity to 88 million tons of oil per year through phased development and the commissioning of Eastern Siberian fields. In addition, an oil pipeline from Skovorodino to the border of the PRC—a so-called “China Spur”—is planned. The future oil pipeline will integrate fully into the existing Transneft trunk pipeline system, giving Russian oil companies the ability to choose the most efficient routes for transporting crude based on current world competition.

A clear and convincing example of the successful development of the offshore shelf was LUKOIL’s placement into service of the Yury Korchagin field in the Russian sector of the Caspian Sea. With Russian Prime Minister Vladimir V. Putin present, the first oil was produced there on April 28, 2010. LUKOIL discovered the field in 2000, and from 2004 to 2009 it invested 34.4 billion rubles in its development. The field’s infrastructure consists of an ice-resistant stationary platform (IRP 1) with a drilling system that has a lift capacity of 617 tons for drilling wells as deep as 24,200 feet; an ice-resistant stationary platform (IRP 2) to house 105 personnel, with an independent survival capacity of 15 days; 36 miles of 12-inch diameter underwater pipeline with wall thickness of ⅝ inches; and floating oil storage with capacity of 28,000 deadweight tons. Oil from the field is transported by shuttle tankers with a capacity of 6,000–12,000 deadweight tons.

The first well in the field was drilled for oil; the second, for associated gas that would be used to independently power the facility. A third well injects water to maintain formation pressure. The wells were drilled using a unique Russian design technology: superlong horizontal holes over three miles long. The uniform radial placement of the wells allows for simultaneous penetration of all pay zones. Drilling is monitored in online mode from onshore via a satellite link. During field development, LUKOIL monitored the northern Caspian Sea by satellite. The satellite data reached the company’s specialists in near-real time via the LUKOIL– Satellite Images [LUKOYL–Kosmosnimki] web service. During the entire study period, monitoring detected no oil pollution within the company’s license tracts.

According to reliable estimates, hydrocarbon reserves in the Yury Korchagin field exceed 270 million barrels of oil equivalent (BOE). The planned maximum annual production level is 2.8 million tons of oil and 35 billion cubic feet (BCF) of gas, and by the end of 2010, 330,000 tons of oil will have been produced at the field.

Still, the bulk of the oil reserves (about 70%) are concentrated in the waters of the North Caspian, in Vladimir Filanovsky field, the biggest of those explored in our country by LUKOIL in the last 20 years, while the bulk of gas reserves (about 40%) are in Khvalynsk field. According to preliminary estimates, the recoverable reserves of these fields are 1 billion tons of oil and 27.6 TCF of gas.

The company plans to begin production at Vladimir Filanovsky field in 2012, and by 2015 it plans to produce 13 million tons of oil and 423 BCF of gas per year from its Caspian fields. By 2020, LUKOIL expects to reach a North Caspian production level of 33 million tons of oil and 635–706 BCF of gas.

LUKOIL is also considering the development of the Timan-Pechora oil and gas province, which is viewed as a critical objective in LUKOIL’s overall strategic program, because the territory of the Komi Republic alone concentrates the richest reserves of “black gold” in two oil and gas regions: Pechora-Kolva (36%) and Izhma-Pechora (29%). Explored reserves in Categories A, B, and C_1, accounting for hydrocarbons already produced, amount to 1.8 billion tons of coal equivalent (16.2% of the Komi Republic’s original resources), including 56% oil and 35% free gas. Preliminary estimates of hydrocarbon reserves are 203 billion TCE, including 70% oil and 23% gas. Currently, the state register of minerals in the Komi Republic lists 137 crude hydrocarbon fields.

LUKOIL’s specific work plan is contained in the “Federal Special-Purpose Program for the Comprehensive Development of Oil and Gas Resources in the Timan-Pechora Province Through 2005 and Beyond,” which was developed with the company’s active participation. Specifically, the company plans to invest 13 billion rubles on geologic exploration alone. Between 2000 and 2007, geologic exploration has resulted in the discovery of nine fields in the Komi Republic and two in the Nenets Autonomous District. In all, the program’s implementation will permit the company to increase its oil reserves by about 440 million tons and its gas reserves by 1 TCF over the course of 10 years. Some 30 new fields are expected to be developed in that time, and oil production in 2010 will grow to 33 million tons, as compared with 14 million tons in 2000.

As a clear example of the extent of Russia’s vast resources, consider the Nenets Autonomous District, where LUKOIL is developing one of northern Timan-Pechora’s biggest fields, South Khylchuyu, where proven oil reserves total over 500 million barrels. The quality of conditioned oil surpasses that of the Russian “Urals” export mixture: its specific gravity is 35.5°API (that of Urals oil is 32.0°API), and its sulfur content is 0.71% (that of the Urals is 1.30%). The project is being developed by the Naryanmarneftegaz joint venture, in which LUKOIL holds a 70% interest and the American company ConocoPhillips holds a 30% interest. In June 2008, construction was completed for Stage One of the South Khylchuyu field. This project includes 32 production wells, an oil conditioning installation with a capacity of 4.2 million tons per year, a system for removing hydrogen sulfide from oil, a tank farm with a total capacity of 1.4 million cubic feet (MMCF), an external delivery pumping station, the 10¾-inch diameter 17.3-mile long Yareyyu–South Khylchuyu high-pressure gas pipeline, a gas conditioning unit with a capacity of 13 BCF per year, a 125-MW generating station, and 178 miles of 220 kV high-voltage lines. In December 2008, construction of Stage Two of the South Khylchuyu field was completed, during which the capacity of the oil conditioning installation was increased by 4.2 million tons per year. A high-pressure compressor station was also built, along with sulfur recycling and storage facilities. The crude produced at the field is transported through a 21-inch diameter pipeline 98 miles in length to the Varandey Oil Loading Terminal, which has a capacity of 13 million tons per year. The terminal is located on the shores of the Barents Sea, and handles 70,000-deadweight-ton tankers that deliver the crude to European and North American markets year round, in part from a floating tank farm in Kola Bay. The target annual oil production level in the field is 8.3 million tons (over 150,000 barrels a day), and is expected to be attained in 2010.

In all, by 2020 LUKOIL plans to commission 60 new crude hydrocarbon fields in the Russian Federation’s Northwest Federal District alone.

Traditional Russian oil-producing regions also have good prospects for the discovery of new oil fields. The Western Siberian Province’s initial total resources and the status of use of known oil reserves show that the region has enormous potential both for oil production stabilization and even growth. So far, no more than 18.2% of initial total oil resources have been produced. According to Igor Shpurov, general director of the Western Siberian Scientific Research Institute of Geology and Geophysics [ZapSibNIIGG], Western Siberia prospects are linked primarily to pre-Jurassic formations. Discoveries are possible in Neocomian deposits in marginal parts of the Western Siberian oil and gas province, which to date have been studied much less than the central area. Major discoveries are also possible at deeper levels containing oil and gas; this applies primarily to the pre-Jurassic sequence, which is virtually unstudied. It has only been penetrated by fewer than 10% of the exploratory wells drilled in Western Siberia. It is thus possible that the pre-Jurassic sequence will soon be the main source for replacement of the crude mineral baseline. The real path to solving this problem is obvious: the scope and efficiency of geologic exploration must be substantially increased.

Another telling example is the 2008 discovery of a new oil field on the right bank of the Ob, in the Tomsk region. The “black gold” produced from the South Pyzhino well is of very high quality. It has low paraffin content, exhibits low density and viscosity, and is free of sulfur. Furthermore, this well has penetrated at least six thick oil and gas formations. Incidentally, nine new fields have been discovered here in the last three years, and reserve growth has exceeded production by a factor of almost four for the first time in recent years. Geologists call this area the Pre-Yenisey oil and gas subprovince. Three superdeep wells have been drilled here, and further stratigraphic drilling is planned. Sufficient data from drilled wells and seismic exploration are available to confirm the prospects of discovering new hydrocarbon fields, and the results considerably increase the oil and gas prospects of the Pre-Yenisey oil and gas subprovince. At present, license-tract formation is nearing completion.

Yet another example concerns LUKOIL–Western Siberia LLC (a wholly owned subsidiary of LUKOIL), which began drilling the first development well at Pyak-Yakha gas-condensate field (Yamal-Nenets Autonomous District) in April 2009. This is the company’s second project, after Nakhodka field, to produce hydrocarbons in the Yamal-Nenets Autonomous District. Medium-term plans call for drilling 55 development wells in this license tract. The proven reserves of Pyak-Yakha field as of the end of 2008 were 70 million barrels of oil and 1.9 TCF of gas. Commercial production at the field is planned for the fourth quarter of 2011. Produced gas will pass through Nakhodka field to the Yamburg gas compressor station, and thence to the Gazprom gas transportation system. Liquid hydrocarbons (oil and gas condensate) will be pumped into the Vankor field oil pipeline (owned by Rosneft Oil Company), for subsequent transmission to the Transneft trunk pipeline system. A 78-mile gas pipeline will be built to Nakhodka field, and a 99-mile pipeline will be built to Vankor field to carry hydrocarbons produced at Pyak-Yakha field.

It is well known that parameters such as well spacing and layout, the existing well utilization rate, the efficiency of the formation pressure-maintenance system, the volume and efficiency of enhanced oil production methods, and the volume and frequency of field studies to monitor development substantially affect oil production efficiency. In this area, enhanced oil production methods, which account for only about 9% of Russia’s total annual oil production at the moment, are assuming a special role in stimulating oil production.

In addition, Russia possesses enormous reserves of unconventional crude hydrocarbons. These include bituminous tars and sands, which can do much to compensate for the shortage of conventional fuels. Suffice it to say that within the territory of Tatarstan alone, Russian geologists have discovered 450 natural tar fields, 150 of them within the operational zone of Tatneft, and 12 of these have been prepared for commercial development. By several estimates, natural tar resources in this Russian republic alone may amount to as much as 7.7 billion tons.

On June 7, 2010, we met Tatneft’s general director, Shafagat Takhautdinov, in Kazan. In the course of the meeting, we specifically discussed questions of future cooperation between our companies. The head of Tatneft showed great interest in the prompt completion of pilot studies by our subsidiary RITEK on a downhole steam generator for in situ heat treatment of high-viscosity crude.

In discussing Russia’s supply of oil reserves, one more very valuable crude hydrocarbon must be considered: natural gas. Experts estimate that Russia ranks first in the world in explored natural gas reserves (32%) and provides up to 30% of world natural gas production. The country has 787 discovered fields, of which 352 are in development. The fields under development concentrate 45.5% of Russia’s total reserves. Initial total resources of free gas amount to 8,338 TCF, including 5,660 TCF on land and 2,677 TCF on the continental shelf. Explored reserves in Categories A, B, and C₁ amount to 1,652 TCF. Estimated reserves in Category C₂ are 501 TCF. Prospective and inferred resources in Categories C₃ and D, which require confirmation by geologic exploration, are 5,749 TCF. The geographic breakdown of gas reserves is irregular. The Yamal-Nenets Autonomous District in Western Siberia, which contains 15 unique fields with reserves of over 18 TCF each, accounts for two-thirds of explored natural gas reserves. The Volga-Urals region accounts for 130 TCF, or 8%; Eastern Siberia, for 56.5 TCF (3.1%); the Far East, for 49.4 TCF (3%); and the European North, for 17.7 TCF (about 1%). Of the total volume of explored reserves, about 55% (concentrated in the Yamal-Nenets Autonomous District) accounts for purely producer gas.

Another very promising hydrocarbon resource in Russia is methane hydrates. The world’s first discovery of free gas under a bed of methane hydrates occurred in 1967, at the Messo-Yakha field in the Yamal-Nenets Autonomous District. Since development began in 1968 using original technology, the field has yielded over 423 MMCF of gas, and since then, over 220 methane hydrate deposits have been discovered. Specialists estimate that natural methane hydrate gas reserves are at least a hundred times greater than in explored gas fields, and Russian scientists believe that research into geologic hydrocarbon pools in the Dolganskoye series will not only eliminate discrepancies in estimating the formation’s gas reserves, but permit assessment of possible pools of heavy crude and methane hydrates and the prospects for discovery of oil and gas pools in Lower Cretaceous and Jurassic deposits.

In all, according to current expert assessments, the Russian Federation’s present supply of oil reserves would last 36–40 years at current rates of consumption, and that of gas would last 75–80 years. Furthermore, the country has all the prerequisites to further increase oil and gas production volumes over the next 30 years. The country’s economic interests will largely be met by further development of the Western Siberian Province, Eastern Siberia, the Timan-Pechora Province, and the continental shelf. These hydrocarbon resources are a valuable heritage of the multiethnic Russian nation and the principal reserve for development of the country’s crude mineral complex over the medium and long term.

The Investment Climate in Russia

The status and problems of the Russian oil and gas industry steadily remain at the center of attention of leading foreign print and electronic media. These often contain statements that, in the past decade, the government has steadily increased its involvement in the Russian oil and gas industry, which could ultimately end in complete nationalization of the industry. And all this could supposedly lead to an exodus of foreign investors from Russia and a substantial slowdown of investment processes.

As chairman of the Energy Policy Committee of the Russian Union of Industrialists and Entrepreneurs, this author has had to answer questions from Western journalists on numerous occasions on the supposedly forthcoming nationalization of the industry. As this author has emphasized repeatedly, these are unfounded and frivolous opinions, without the slightest basis in fact.

In fact, the Russian oil and gas industry no longer has any state-owned companies in the pure (classical) sense. For example, the state does hold a 50.02% interest in the authorized capital of Gazprom, the leader of the Russian oil and gas industry, which is fourth in the world in market capitalization with $354.6 billion, while the remaining stock is held by a wide range of strategic, institutional, and individual investors, including foreign stockholders with interests amounting to 7.448%. Burckhard Bergmann, chairman of the Board of E.ON Ruhrgas AG, a major German corporation, sits on the Gazprom Board of Directors.

If we look at the ownership breakdown of a key Gazprom subsidiary, Gazprom Neft, we see a similar picture. Gazprom itself holds a 75% stake in the company, while 20% is held by a consortium of the Italian corporations ENI and Enel. The Gazprom Neft Board of Directors includes representatives of foreign stockholders: Marco Alvera, senior vice president for deliveries and portfolio investment development of ENI S.p.A Moscow Milan, and Stefano Cao, ENI senior director for production.

The authorized capital of Rosneft, which the Western media persist in calling “state-owned,” is 105,981,778 rubles 17 kopecks (10,598,177,817 shares of common stock) after consolidation of 12 subsidiaries. The government, through Rosneftegaz, owns 75.16% of the company’s authorized capital, with the remaining shares held by a broad range of strategic, institutional, and individual Russian and foreign investors. Until recently, the American financial corporation Citigroup held a 110-million-share interest in the company, or about 1% of its stock, based on a market capitalization of about $98 billion. Rosneft’s Board of Directors includes Hans-Joerg Rudloff, board chairman of Britain’s Barclays Capital, and US citizen Peter O’Brien is a company vice president. Incidentally, data from an independent audit of oil and gas reserves by DeGolyer & MacNaughton showed the company had proven reserves of 2.669 billion tons (17.694 billion barrels) of oil and 27.7 TCF of natural gas per the PRMS classification as of December 31, 2008. Thanks to the large volume and high efficiency of geologic exploration, its proven hydrocarbon reserves increased 2.8% in 2008, to 3.364 billion tons of oil equivalent (TOE), or 22.307 billion BOE.

With respect to the Transneft Pipeline Joint-Stock Company, which is also often characterized as wholly state-owned, it turns out that the state does not hold a 100% interest at all, but 75%, and the remainder of the preferred stock belongs to private stockholders. Transneft’s acquisition of Transnefteprodukt, which transports petroleum products within the Russian Federation, is now being finalized.

The above examples clearly show that although the Russian government owns some portion of the total shares of Gazprom, Rosneft, Transneft, and many other companies, this absolutely does not hamper the management of the oil and gas business on market commercial principles and in the interests of product consumers and stockholders.

Idle statements by certain Western media on the reduction of foreign investment activity in the Russian oil and gas industry due to extension of ever-stricter government control over the hydrocarbon assets of Russia’s economic growth are equally exaggerated.

The energy policies of leading nations have, above all, always been based on a well-thought-out and intelligent energy strategy that includes both an economic ideology that is distinguished by its long-term sustainability, and specific numeric indicators for fuel and energy industrial development vectors. We should clearly understand, in turn, that only a powerful state with an effective administrative system can support both the normal functioning of a fuel and energy market and the institution of private property in the industry.

Recently, a favorable investment climate for foreign investors has been forming in Russia at an accelerated pace. The Russian government’s policy is based on the principle that investments are what the oil and gas industry needs to reach a qualitatively new level.

With clearly defined investment strategies, foreign investments have now become an important component of programs to modernize the Russian oil and gas industry. For example, at its October 11, 2007 meeting, the executive board of Gazprom took special note of the fact that attracting foreign partners to corporate projects can be regarded as an effective mechanism for achieving strategic objectives and, in particular, for reinforcing the vertical integration of the company’s business.

Another clear example and a convincing confirmation of the effectiveness of Russian-German energy partnership is the plan to develop South Russian field, which is located in the Krasny Selkup District of the Yamal-Nenets Autonomous District. The development license is held by a Gazprom subsidiary, Severneftegazprom. According to the latest data, the South Russian oil and gas field has Category A + B + C₁ gas reserves of 29 TCF and Category C₂ gas reserves of 7.4 TCF. In addition, oil reserves are estimated at 6.3 million tons. Gazprom has used South Russian field to swap assets with BASF and E.ON. Currently, BASF owns an interest amounting to 25% minus one voting share and 10% of the nonvoting stock (one share of preferred stock) in Severneftegazprom, while the Russian company, in turn, has increased its interest in the Russian-German joint venture Wingas GmbH from 35% to 50% minus one share and gained a 49% equity interest in Wintershall, a BASF subsidiary.

Speaking on December 18, 2007 at a gala ceremony marking the beginning of production from the field, Russian President Dmitry Medvedev⁵ stressed that, “This is a big undertaking and a very important one for us, essentially representing the development and strengthening of the rise of the Russian North. There is no doubt that the asset swap between the Russian companies, between Gazprom and BASF—and this was the principle on which the project’s realization was based—will improve the competitiveness of both companies and strengthen their positions on global markets.... This is a common investment to ensure sustainable energy security for Europe and the flourishing of the entire European continent.... Russia is open to such large and serious business projects, and to bold business initiatives for mutually profitable cooperation.” The annual industrial production volume at South Russian field is planned to be 882 BCF of natural gas.

On the Yamal Peninsula, TNK-BP [“Tyumen Oil Company-British Petroleum”] plans to invest about $60 million in the development of Russian fields this year. Oil production has begun, and two wells have been drilled, each producing about 165 tons of oil per day. Another production well is being drilled, and another exploratory well is planned. The field’s reserves are 440 million tons; geologic exploration could increase that figure.

Many more examples could be cited from recent times. In Western Siberia, Salym Petroleum Development NY, a joint venture of Shell Salym Development BV and Evikhon (a subsidiary of Siberia Energy), is successfully developing the Salym group of oil fields, which include the West Salym, Upper Salym, and Vadelyp fields. In 2007, 108 new wells were brought online and 180 miles of rock were drilled at the Salym fields. Daily oil production was 100,000 barrels. Total oil production last year more than doubled as compared to 2006, to 4.7 million tons. The company has not only achieved positive cash flow, but has also become profitable and has begun repaying its stockholder loans. According to its general director, Harry Brekelmans, the company plans to invest $200–250 million to develop the Salym project this year. From the beginning of field development in 2003 to the end of the current year [2009], and taking current-year investments into account, $1.2 billion will have been invested in the project. And by the end of the current decade, the total oil production specified by the technological plan for the Salym Group will exceed 6.6 million tons (about 44 million barrels) per year.

In the same region, the Italian corporations Eni and Enel have invested $852 million to form the joint venture Northern Energy (with 60% and 40% interests, respectively) to buy up some of the production assets of the bankrupt Yukos. In particular, the consortium has acquired the Arktikgaz, Urengoyl Inc, and Neftegaztekhnologiya oil production enterprises, which hold hydrocarbon development and production licenses in the Yamal-Nenets Autonomous District.

Also in Western Siberia in December 2007, the American oil service company Halliburton Co. signed a multimillion-dollar contract with Rosneft to service oil fields in Western Siberia. The American company won an order for hydraulic fracturing at 317 oil wells in the Ob Valley region.

In turn, the American oil services company Weatherford International Ltd. announced the acquisition, in February 2008, of Neftemashvnedreniye (Noyabrsk, Tyumen Region), which specializes in the manufacture of oil and gas production equipment. Neftemashvnedreniye produces flowing-well equipment such as “Christmas trees.” This isn’t Weatherford International Ltd.’s first acquisition in Russia, either: In late 2007, it acquired a stock interest in Borets, a major Moscow factory, which makes submersible downhole pumps for oil production. It is significant that the American company consistently acquires stock in Russian enterprises that make oil and gas production equipment.

Mention can also be made of the successful activities of Victoria Oil & Gas, a British company with a 74.6% stock interest in Severgazinvest, which is developing the promising West Medvezhye gas-condensate field in the Yamal-Nenets Autonomous District.

An instructive example of foreign investment in Russia occurred on March 21, 2008 in Tyumen, capital of Western Siberia, when Schlumberger formally opened its Siberian Oil Production Training Center, which is designed to train and retrain oil and gas professionals. The Center has no counterpart anywhere in the world, and the 370-acre campus includes a training building, dormitory cottages for students, and a well-equipped area with instructional wells for training in hydraulic fracturing, well servicing, control of drilling systems, etc. The Center can currently accommodate 300 specialists for training. In addition, a training course has been designed to teach safe driving, and a stadium and athletic complex have been built. Construction is actively continuing on the Center’s grounds: An area for geophysical research will be built, and three new training wells will be drilled. In all, the leading service company plans to invest at least $100 million in the project. This is but one of the major investment projects by international companies in Russia.

In Eastern Siberia, the joint venture Verkhnechonskneftegaz [“Upper Chona Oil and Gas”], whose stockholders are TNK-BP and Rosneft, is developing the Upper Chona gas-condensate field in the Katanga District, Irkutsk Region. The field is one of the largest in the region, with recoverable Category C₁ and C₂ reserves of 222 million tons of oil and 3.7 million tons of gas condensate. Natural gas reserves are estimated at 4.6 TCF. The company’s board of directors includes foreign citizens Gary Jones, Upper Chona project director, and David Jenkins, research director.

It should also be mentioned that on January 15, 2008, a new vertically integrated oil company appeared in Russia, formed under market conditions by the merger of Alliance, a Russian corporation, and West Siberian Resources (WSR), a Swedish firm that operates in three major oil regions of the Russian Federation: Western Siberia (Tomsk Region), Timan-Pechora, and the Volga-Urals region. The merger is of mutual benefit, because it creates a synergy of production and refining capacity. The merged company will have proven and inferred reserves of 484 million barrels of oil, a production volume of 51,000 barrels per day, and a refining volume of 70,000 barrels per day. The company’s organization includes 255 retail filling stations and 24 oil tank farms. The merged company’s capitalization, according to management estimates, will grow to $2.5 billion, with Alliance’s capital estimated at $1.5 billion today and WSR’s at $900 million. The merger is expected to more than double the company’s net profit and income, especially after commissioning the ESPO pipeline and reconstructing the Khabarovsk Refinery to achieve a refining yield of 93%, which will permit manufacture of Euro-5 fuel and Jet-1 aviation kerosene that could be exported to China and the Asia-Pacific Region, among others.

Another good example of how Western investors firmly believe in the future of the Russian oil and gas industry occurred in early September 2009, when Swiss company Sulzer AG completed building the first enterprise on Russian territory based on the Serpukhov Plant in eastern Russia. The company invested over $8 million in the project, for a plant that specializes in the manufacture of so-called “plates” and “packing”—key components that determine the effectiveness of various chemical assemblies for oil refining and gas processing, petrochemistry, chemistry, and other fields. The new plant will supplement and partially replace established imports of equipment to Russia from other Sulzer AG enterprises in Europe and Asia. In 2008, Sulzer’s sales on Russian territory amounted to €15 million. The company’s potential and existing clients are in the oil, gas, and chemical industries.

The Russian government continues to systematically implement new steps to improve the investment climate in the Russian oil and gas industry. On December 3, 2007, the Russian president signed the federal law, “On the Amendment of Article 10 of the Russian Federation Law, ‘On Minerals,’ ” which extended the periods for use of the subsurface for geologic study, as reported by the Kremlin press service. The law was adopted by the State Duma on November 16, 2007 and approved by the Federation Council on November 23. It extends the maximum period for use of the subsurface for purposes of geologic study on mineral parcels of inland sea waters, territorial seas, and the continental shelf to 10 years. The previous period had been limited to five years, but analysis and generalization of mineral use practice showed that the term was clearly inadequate for effective performance of geologic studies of the subsurface.

On April 2, 2008, the Russian State Duma adopted the law, “On the Procedure for Effecting Foreign Investments in Business Entities of Strategic Importance for Safeguarding the National Defense and National Security.” State Duma Chairman Boris Gryzlov noted the importance of the legislation: “We are introducing a certain element of protection for our strategic industries against the participation of foreign capital and restricting this investment participation, we are raising a barrier in control.” Endorsement is required for any deal by which foreign investors would acquire more than 50% of the voting shares that constitute the equity of a commercial partnership (joint-stock company or limited liability corporation) of strategic importance to the defense and security of the state. Deals involving foreign states and international organizations are subject to more stringent requirements. These entities will need to secure endorsement to acquire more than 25% of the stock in a strategic company. The final decision may be made after three months, or a maximum of six. The law does not apply retroactively, but authorities must be notified of ownership shares exceeding 5% of a strategic company. From several initial assessments and comments in the Western media, we can conclude that as expected, foreign investors regard this Russian law more than favorably, because it introduces precise clarity and definiteness for the development and implementation of a foreign business’s strategy in Russia.

The Russian business community has not remained aloof to this important activity, and is undertaking the necessary actions. On February 4, 2008 in Moscow, the Russian Union of Industrialists and Entrepreneurs and the Russian Federation Chamber of Commerce and Industry signed a cooperation agreement that specifies an effective partnership for the formation of a favorable business climate and consolidation of the positive reputation of Russian business. The agreement is for four years and anticipates close cooperation in the following major areas: development of a coordinated position on critical socioeconomic issues; development and implementation of steps to protect entrepreneurs’ rights and interests; improvement of corporate governance laws and practice; comprehensive strengthening of the public-private partnership; and active development of foreign-trade cooperation and international relations between Russian entrepreneurs and foreign partners and representative organizations of the business community.

Russian Offshore Prospects

From time to time, articles in foreign publications maintain that Russia is imposing unjustifiably rigid constraints on the operation of foreign companies to develop crude hydrocarbon fields on the Russian shelf. In this matter as well, such journalistic claims are far from the truth.

First of all, offshore shelf projects located on Russian territory present a great geologic risk, and there is an objective need here for Russian and foreign companies to work together to study the conditions associated with these projects and to engage in geologic exploration to achieve the desired goal.

Quite a few examples can be cited of the successful operation of Western companies on the Russian shelf. The Sakhalin-1 project, one of the largest involving direct foreign investment in the Russian economy, ranks among the most promising and difficult projects developed by members of many countries in the 21st century. The project involves the development of oil and gas reserves on the northeastern shelf of Sakhalin Island. The project area includes the Chayvo, Odoptu, and Arkutun-Dagi fields. Total recoverable reserves for the project amount to 338 million tons (2.3 billion barrels) of oil and 17.1 TCF of gas. Exxon Neftegaz Limited, an affiliate of ExxonMobil, is the Sakhalin-1 project operator. The Sakhalin-1 Consortium also includes two Russian companies, Sakhalinmorneftegaz-Shelf and RN-Astra, the Japanese company Sakhalin Oil and Gas Development Co., Ltd., and the Indian company ONGK Videsh Ltd. The Sakhalin-1 project is a clear example of the successful realization of a joint large-scale investment program by Russian and foreign companies, achieving on-schedule start of oil production, the timely completion of an export pipeline and terminal, the beginning of oil exports and the early commissioning of an onshore product conditioning complex, a successful production increase to a target level of 37,500 tons (250,000 barrels) of oil per day, and the drilling of record numbers of highly deviated wells. The project now delivers oil to international markets and natural gas to the Russian Far East. Incidentally, Nippon Oil Corp., Japan’s biggest refiner, signed a long-term contract in February 2009 to buy Russian crude from Sakhalin fields. Every quarter, it purchases one tanker, or 720,000 barrels, of crude produced by the Sakhalin-1 project. The Japanese company made this decision in order to reduce its dependence on deliveries from the unstable Middle East, and to substantially reduce transportation costs. Previously, Nippon Oil bought 87% of its crude in the Middle East, but deliveries from there take two weeks to reach Japan, as opposed to only four days from Sakhalin. In the opinion of Hirofumi Kawachi, an analyst for the Mizuho Investors Securities Co. consulting firm, “the acquisition of oil from Sakhalin offers a clear advantage in view of its proximity to Japan, because the buyer can save on shipping costs.”⁶ According to reports in Bloomberg News, all six leading Japanese refineries have made test purchases of low-sulfur Sakhalin crude.

In addition to the Sakhalin-1 project, Rosneft is also realizing second-wave projects such as the Veni block of Sakhalin-3, and has already invited the British corporation BP to participate in a joint venture in the Sakhalin-4 and Sakhalin-5 projects.

Another instructive example occurred in February 2009, in the town of Prigorodny on Sakhalin Island, where a ceremonial opening was held for Russia’s first liquefied natural gas processing plant on Sakhalin. The enterprise’s launch was marked by the pressing of a symbolic button by the heads of the companies holding stock in the project: Aleksey Miller of Gazprom, Jeroen van der Veer of Royal Dutch/Shell Group, Shoei Utsuda of Mitsui, and Yorihiko Kojima of Mitsubishi. Russian President Dmitry Medvedev participated in the plant opening ceremony, as did representatives of the foreign countries whose companies are involved in the project. Japan was represented by Prime Minister Taro Aso; Great Britain by Prince Andrew, Duke of York; the Netherlands by Minister of Economics Maria van der Hoeven. The Duke of York, in particular, noted that the project would help meet the world’s future demand for gas deliveries, and Great Britain regarded Russia “as a sufficiently reliable supplier of energy resources.” In turn, Dutch Economics Minister van der Hoeven said that with the opening of this plant, Russia would gain new opportunities to supply energy resources, which would become a major trump card for Russia in the future. “We expect the plant to make it possible in the future to solve many problems, including demand,” she said. The LNG plant will process gas produced under the Sakhalin-2 international project. The plant’s annual capacity is 10.6 million tons of “blue” fuel. Japanese, American, and South Korean companies have already bought most of the gas for the next 25 years. The liquefied gas will be transported from the plant in tankers holding 635,000 cubic feet (635 MCF) to 5.1 MMCF of gas.

The Sakhalin-2 project is being implemented under a production-sharing agreement (PSA) signed with the Russian Federation in 1994. Sakhalin Energy shareholders are Gazprom (50% plus one share), Royal Dutch/Shell Group (27.5%), and the Japanese companies Mitsui (12.5%) and Mitsubishi (10%). Sakhalin Energy is the project operator.

The total cost of Sakhalin-2 is about $20 billion. The project is developing the Piltun-Astokh and Lunskoye fields, whose recoverable reserves are estimated at 165 million tons of oil and 17.7 TCF of gas.

Another piece of news related to the development of the Sakhalin shelf involves the Russian company Maritime Marine Shipping Line that, three years ago, in collaboration with the Japanese companies Mitsui O.S.K. Lines, Ltd. (MOL) and Kawasaki Kisen Kaisha, Ltd., won a bid to transport liquefied natural gas. In the spring of 2009, Japan successfully completed testing a ship that would carry liquefied natural gas produced under Sakhalin-2 from the Sakhalin terminal at Prigorodnoye. This liquefied natural gas carrier, the Grand Mereya, was built at a Japanese shipyard by Mitsui Engineering and Shipbuilding and is designed to carry 5.2 MMCF of liquefied gas. After testing, the ship began operating on a long-term time charter between the MOL/K Line/PRISCO consortium and the Sakhalin-2 project operator Sakhalin Energy.

Active work is going on in other parts of the Far Eastern shelf as well. In 2009, Rosneft began exploratory drilling on the West Kamchatka shelf. This parcel poses quite a challenge, even compared to the Sakhalin fields, as it lies far from supply bases, and moreover, very strict environmental requirements apply. In addition, project challenges include a weak market of regional subcontractors. Difficult production conditions and the difficult process of obtaining all imaginable work permits mean that geologic exploration takes more time. For this reason, the phases of geologic exploration for shelf projects, including the Kamchatka project, will take at least 10 years. In the first phase of geologic exploration off Kamchatka, 2D and 3D seismic exploration has been performed. The process of further geologic exploration will include drilling of several more wells. The city of Magadan has been chosen as the main shore support base to supply these operations.

Rosneft is pursuing a West Kamchatka offshore development project with a Korean consortium, Korea Kamchatka Co. Limited (KKC). The Russian company owns 60% of the project; KKC, 40%. A 50% share of KKC is owned by the Korean National Oil Company (KNOC), while Korea Gas Corp., GS-Caltex Corp., SK Corp, and Daewoo International Corp. each own 10%, and Kumho Petrochemical and Hyundai Corp., 5% each. The project operator and holder of the license for the geologic study of the West Kamchatka license tract is Kamchatneftegaz LLC. The license tract has an area of over 23,000 square miles, and as of 2006, the inferred resources, as estimated by DeGolyer & MacNaughton, were 2 billion tons of oil and 81.2 TCF of gas. Up to $300 million is to be allocated for work on the West Kamchatka shelf in the immediate future; $90 million has been invested since work began on the project. According to expert estimates, development of the Kamchatka shelf will require a total investment of approximately $24 billion.

Geologic and engineering studies have begun in the Lopukhovaya hydrocarbon parcel, located on northern Sakhalin and licensed to Gazprom Neft. Drilling of an offshore geologic exploratory well has already begun on the Tumansky license tract near Anadyr. According to preliminary data, Gazprom Neft calculates the tract’s C₁ + C₂ reserves to be 35 million tons. It has been deemed advisable to enlist several foreign partners for this tract, and negotiations are now underway.

A good example of international cooperation on the Russian shelf is the involvement of two leading foreign companies, Total (France) and Statoil Hydro (Norway), along with Gazprom, in the development of the enormous Shtokman gas-condensate field, which is located in the central shelf of the Russian sector of the Barents Sea. The licensee is Sevmorneftegaz, a wholly owned subsidiary of Gazprom. According to January 2006 data, Shtokman Category C₁ + C₂ reserves approved by the State Commission for Mineral Reserves [GKZ] of the Russian Ministry of Natural Resources and Ecology amount to about 130.6 TCF of gas and more than 34 million tons of gas condensate.

On February 21, 2008, Gazprom, Total, and Statoil Hydro formed the Shtokman Development Company, a special-purpose entity to develop Phase One of the Shtokman gas-condensate field. Gazprom’s head, Aleksey Miller, was approved as chairman of its Board of Directors. Shtokman Development Company was registered at Zug, Switzerland, and 51% of to the company is owned by Gazprom, 25% by Total, and 24% by Statoil Hydro.

Over the next two years, Shtokman Development Company will work on issues related to field development planning, including preliminary design work. Then, based on studies performed at the design stage, an investment plan will be presented to investors for a decision. The plan will include the necessary costs and investments required to complete the project, as well as a work schedule. This will form the basis for adopting a final investment decision on field development. Several experts estimate the total cost of developing Shtokman Field to be in the range of $43–44 billion. Investment in Phase One of the Shtokman project is estimated at $12 billion. In this phase, production is expected to reach 837 BCF of gas per year, 50% of which is to be delivered to a gas pipeline, and the other 50% sent for production of liquefied natural gas (LNG). The annual LNG output could amount to 8.3 million tons in Phase One, with expansion to 16.5 million tons in Phase Two and 33 million tons in Phase Three. The gas will be delivered both to Europe and to countries of the Atlantic Basin. Gas pipeline deliveries are scheduled for 2013; those of LNG, for 2014. A site has been selected in the town of Teriberka, Murmansk region, for construction of a plant to liquefy gas from the Shtokman gas-condensate field.

Examples also exist of successful international cooperation in the Russian sector of the Caspian Sea. The British company Timan Oil & Gas plc is developing two blocks, Izberbash 2 and Sulak 4, in the northern part of the Caspian. They have completed 3D seismic exploration, identified prospect structures for drilling, estimated reserves according to Russian standards, and are completing preparation for exploratory drilling.

One more important aspect must be emphasized. The Russian government plans to approve an important document with special environmental requirements applicable to the exploration and development of oil fields in the Caspian zone. A “zero discharge” requirement will apply in the zone of this unique water area, under which no discharges or emissions into the waters will be permitted during oil production. The innovative technology necessary to comply with these requirements has been successfully used by LUKOIL in developing oil fields in the Caspian using the Astra platform, providing convincing evidence that our country is actively seeking to fulfill Russia’s obligations under the “Framework Convention for the Protection of the Marine Environment of the Caspian Sea,” signed by the Caspian littoral states in 2003. The Convention, which obligates Azerbaijan, Iran, Kazakhstan, Russia, and Turkmenistan to combat pollution of the Caspian and make reasonable use of its resources, entered into force in 2006. Under its provisions, the Caspian littoral states must pool their efforts to restore the natural environment of the Caspian and guarantee its environmental security.

Without a doubt, further research in the Arctic will be an important part of the country’s program for industrial development of the oil and gas resources of Russia’s offshore shelf. During the first high-latitude deep-water expedition in Russian history, in August 2007, a large volume of scientific research was performed within the scope of the Third International Polar Year, and the Mir deep-submergence vehicles submerged at the North Pole for the first time. Over 15 days, the Rosgidromet [Federal Service for Hydrometeorology and Environmental Monitoring] research vessel Akademik Fëdorov [“Academician Fëdorov”] and the Murmansk Marine Shipping Line’s nuclear icebreaker Rossiya [“Russia”] overcame nearly 2,500 miles of ice in the world’s harshest and coldest ocean. During the Arctic 2007 expedition, water, ice, and soil samples were collected in the most scientifically interesting parts of the ocean, over the Lomonosov and Gakkel Ridges and even at the North Pole, which the Akademik Fëdorov and Rossiya reached on August 1. On August 2, the Mir 1 and Mir 2 deep-submergence vehicles worked for almost 10 hours in the ocean depths at the point where the Earth’s meridians converge, completing a dive to a depth of about 14,000 feet. A Russian flag made of superstrong metal was planted on the bottom, and a time capsule, the flag of the Third International Polar Year, and a memorial medal were emplaced as well. To a certain extent, the results of the Russian polar expedition to the North Pole should form the foundation for a Russian position when the nationality of this part of the shelf is decided upon by the United Nations.

Surprisingly, several countries of the Arctic region, including Canada, have reacted completely inappropriately to the planting of the Russian flag on the sea floor. In this author’s opinion, there should be no grounds for any worry or alarm here. Recall that in 1969, American astronauts planted a flag on the moon, but it is commonly understood that Earth’s satellite has not become the property of the US. Moreover, our government has repeatedly stressed that Russia will act in the Arctic only within specific international procedures and through the UN, and will strictly abide by accepted international norms.

A further illustration of the Russian government’s constructive position is its approval, on June 16, 2010, of the Russian Geologic Strategy through 2030. Within that framework, the state of knowledge of the continental shelf and inland seas is forecast to grow by nearly double by 2030. (As of today, the shelf is about 42% explored; this figure could grow to 44% by 2012, to 60% by 2020, and to 80% by 2030.) Such progress is made possible by the more rapid introduction of innovative oil exploration and production technologies. The Russian state is prepared to allocate its own money to develop innovative projects, to introduce lease financing of similar initiatives, to offer state guarantees to private investors who make loans for innovative projects, and to subsidize interest rates on commercial bank loans. Financial incentives are also planned using tax benefits for enterprises engaged in innovative activities, and reduced customs duties will be levied on geologic exploration equipment that is unlike any manufactured in Russia. In addition, the Ministry of Natural Resources and Ecology intends to propose steps as early as 2011 to ensure market turnover of mineral prospecting and assessment licenses.

Using the Potential of High Oil and Gas Technologies

The foreign trade press commonly makes rather dubious assessments regarding the low technical and technological level of Russia’s oil and gas industry. Sometimes it is even asserted that Russian service companies in the oil and gas industry lag so far behind Western corporations that they will not be able to catch up in the foreseeable future.

On May 20, 2008, at the Standartneftegaz-2008 conference in Moscow on the standardization of oil and gas equipment, Russian oil and gas workers discussed in detail the problem of preparing industry standards. The conference was held to address the urgent need to improve obsolete Russian oil and gas equipment standards and to harmonize them with international standards. The conference examined questions of ensuring equipment safety, which goes a long way toward determining work safety in the entire oil and gas industry. The conference was attended by oil and gas equipment developers, manufacturers, and consumers, as well as by government agencies. A serious positive occurrence noted by participants was the fact that the Russian Federal Agency for Technical Regulation and Metrology [Rostekhregulirovaniye] had completed organizing a Technical Committee on Oil and Gas Industry Standardization. The technical committee’s primary task is to write new standards in the interests of the industry and to harmonize them with international standards. The Technical Committee on Oil and Gas Industry Standardization is headed by Vlada Rusakova, member of the executive board of Gazprom. Gazprom was responsible for the work of three subcommittees; Rosneft, for that of the subcommittee on oil production. The subcommittee on the development of offshore fields was the responsibility of LUKOIL, and the subcommittee on equipment and materials was the responsibility of the Russian Association of Oil and Gas Equipment Manufacturers. On the whole, the Standartneftegaz-2008 conference was an important step and proposed a set of measures to the government to raise the competitiveness of Russian industrial products for the oil and gas industry.

In turn, the first international forum on “Oil and Gas Service and Equipment: Russian Experience and International Cooperation,” which took place in late May 2008 in Tyumen, convincingly showed that the so-called technical and technological backwardness of Russian oil service companies is steadily becoming a thing of the past. While it is true that certain high-tech foreign service companies such as Baker Hughes, Halliburton, Schlumberger, etc., have patents on very efficient technologies that Russian companies do not have, the well-known analytic research company Douglas-Westwood estimates the size of Russia’s oil service market in 2007 to have been $12.5 billion, which will increase to $22 billion by 2011, i.e., the market will almost double in three years. Experts estimate that the biggest growth here will be in drilling. Currently, the annual volume of drilling work approaches 32.8 million feet per year, and by 2010 it will exceed 49 million feet. A challenging mining geology makes the current cost of drilling $125 per foot in Western Siberia and $610 in Eastern Siberia. By 2011, the cost of drilling is expected to exceed $150 per foot in Western Siberia and to reach $915 in Eastern Siberia.

Under such conditions, the obvious striving of Western service companies to expand their activity in Russia is readily apparent. For example, in early November 2007, Halliburton Co. closed a deal to acquire the leading Russian drilling company Burservis (Burservice). Simon Turton, Halliburton Country Vice President for Russia, remarked: “Over the past several years, Halliburton has successfully expanded our directional drilling and mud-logging operations in Western Siberia. This acquisition enables Halliburton to expand our operations to serve oil and gas customers in... Russia, thanks to Burservice’s outstanding reputation for service quality.”⁷

Drilling and capital well rework sectors still overwhelmingly belong to Russian contractors, however. Russia is now creating unique service technologies, which are original process solutions of suitable price and quality.

An example of this occurred in mid-February 2009, at a base on the Upper Salym field near the village of Salym (Khanty-Mansi Autonomous District), where a fundamentally new mobile drilling rig was demonstrated. This was the MBU 3200/200-DER, which was developed by specialists of the Russian company Uralmash Drilling Equipment (Yekaterinburg). The rig’s development also involved German engineers, whose participation allowed the new design to take all European requirements for equipment safety and technical characteristics into account.

The mobile drilling rig demonstrated at Salym field has strong competitive advantages. It is a piece of heavy drilling equipment, with a load capacity of 220 tons, capable of drilling to a depth of 10,500 feet. The rig has an adjustable drive and can be operated at an ambient temperature of between –49°F and +104°F. It can also be used for well workover. The rig’s basic equipment is broken down into vehicle-mounted subassemblies that are transported to oil fields and assembled using fifth wheel tractors. Other subassemblies and large units are conveyed by general purpose vehicles. The rig’s modules include all necessary connections, heating systems, control panels, and electrical equipment, and the equipment is certified to API standards. The new rig has been successfully used by specialists at KCA Deutag, the well-known German drilling contractor.

After the demonstration, leading Russian experts stressed that the production of a new-generation drilling rig meeting international standards was a great victory for Russian mechanical engineers. Its use at Russian fields will undoubtedly raise the technological and commercial efficiency of oil and gas projects, and also ensure the environmental safety of drilling processes. Gazprom’s equipment retooling program already contains a line item for the purchase of the MBU 3200/200 DER-M rig, and the first batch of five drilling rigs has already been delivered to replace equipment at the Orenburg gas field.

Another example occurred in February of 2009, when the Russian Hydraulic Machines and Systems investment and industrial group simultaneously won three tenders to deliver pumping and oilfield equipment to Verkhnechonskneftegaz, operating in Eastern Siberia. The total value of tenders won was around 60 million rubles, in a competition where leading foreign companies also participated in the bidding. During this year, Russian manufacturers supplied oil workers with type NPV (“vertical oil booster”) high-performance vertical pumps produced by Nasosenergomash, and also modern equipment for a formation pressure maintenance system (manifold subassemblies) and pumping stations.

In 2009, the Russian company Grasis delivered a mobile nitrogen station to Naryanmarneftegaz LLC, a joint venture of LUKOIL and the American company ConocoPhillips. The station is intended to implement an oil-conditioning process at the South Khylchuyu central collection point. The mobile membrane nitrogen station is designed to produce 250 Nm³/h of 98% pure nitrogen at a pressure of 40 bar.⁸ The station is packaged in an enclosure having dimensions of 39 × 8 × 8 feet. Control of the station is as simple and convenient as possible, allowing such equipment to be operated by personnel without requiring special training.

The encouraging prospects of the Russian oil and gas equipment market have helped accelerate integration processes. In March 2009, the Russian Integra group announced the creation of a company to service oil and gas equipment. The new enterprise, called Integra-MashServis, was formed on the basis of subdivisions of Uralmash Drilling Equipment (Yekaterinburg). The new company’s main task is to provide a broad range of highly skilled services on an expedited basis in the areas of oil and gas equipment industrial safety expert review, oil and gas equipment examination and technical diagnosis of oil and gas equipment, drilling equipment overhaul, drilling rig and equipment upgrading, and oil and gas equipment servicing.

Integra group management considers the prospects for oil and gas equipment servicing to be very favorable as a market segment. They estimate that around 70% of the active drilling equipment in Russia has become obsolete, and that a significant portion of the growing demand for drilling rigs (the result of increased drilling volume) remains completely unsatisfied. This situation creates great demand, on the part of production companies, for comprehensive service of obsolete equipment, including overhaul and upgrading, provision of spare parts, and maintenance. Demand is also increased by the fact that Russian oil companies are now actively replacing imported field equipment and technology.

Russian products are now finding demand in other countries. Russian oil machine-building enterprises were first able to enter the Central European market in 2009. For example, Korvet (Kurgan) supplied the Serbian company Naftna Industry a Srbije (NIS) with a batch of “Christmas trees” for oil production, equipment that the Serbian company had earlier procured from the American companies Weatherford and Cameron. Moreover, this company also ordered oil producing pumps made by Alnas (part of the Rimera Group), and a contract was signed with the Ozna Group (Ufa) to deliver Impuls units for well flow rate measurement.

On March 25, 2010, LUKOIL-Kaliningradmorneft (a wholly owned subsidiary of LUKOIL) introduced the Yermak, a new Russian drilling rig, at its structural metalwork production plant in Kaliningrad. The Yermak features a unique hydraulic travel system that allows it to move incrementally in all directions and to rotate 360 degrees about its axis. A characteristic of this rig is that it can be used for both development and exploratory drilling. It has a load capacity of 496 tons and can drill down to 21,325 feet. It is equipped with a 2,000-horsepower drawworks, three 1,600-horsepower mud pumps, a 550-ton top drive, and a 1,150-horse-power rotary table. The Yermak drilling rig has been modified to operate under various climatic zones, and in particular, for work under cold Far North conditions and at high temperatures in hot and humid climates.

On the Agenda: Energy Conservation

Foreign media reports sometimes claim that the Russian economy wastes too much energy and, unlike European countries, is very slow at implementing energy conservation programs. This not-so-simple issue also warrants examination.

International Energy Agency data do show that the GDP energy/ output ratio in Russia is 2.5 times higher than in the US, and 3.5 times higher than in Great Britain. Even Canada, with its harsh climatic conditions, consumes only half as much energy per unit of production as Russia does.

Unfortunately, 30–40% of the energy resources our country produces are lost in its worn-out utility networks. Ministry of Energy data indicate that Russia does lose around 440 million TCE every year due to the lack of energy conservation.

Today, growth of the country’s production and energy capacities requires enormous resources. At the same time, energy shortages in certain regions are due not only to high rates of economic growth, but also to low efficiency in the use of gas, electrical, and thermal energy. This is why increasing the economic efficiency of Russian companies and, consequently, strengthening their competitiveness through the use of energy-saving technologies, production upgrades, and their own R&D in this area are becoming highly relevant subjects. Data from the Russian Center for Energy Efficiency (CENEf) indicate that while the potential growth in the production of energy resources is approximately 110 million TCE, the potential for energy conservation is 408–430 million TCE. The Center’s experts concluded that if the margin of energy efficiency improvement in Russia were to be completely exploited, Russia’s economy would confidently continue to grow for 80 years, without having to increase energy production and consumption.

In a speech in September 2009, President Medvedev clearly formulated the goal of achieving world energy leadership by introducing new resource-saving technologies based on intense processing of renewable raw materials. Sergey Chemezov, head of the Rostekhnologiya corporation, was delegated the task of introducing high-efficiency technologies both in production and in the area of all public utilities on the basis of six key energy efficiency and energy conservation projects: “Count, Save, and Pay,” “New Light,” “The Energy-Efficient Residential Quarter,” “Small-Scale Integrated Power,” “Innovative Energy,” and “Energy-Efficient Technologies in Government Institutions.”

Today, development and implementation of a new energy policy based on the highly efficient use of every ruble invested, is becoming one of the main priorities for taking the Russian economy to a qualitatively new level. This trend is based on increasing the volume of production and the export of fuel and energy resources produced by major Russian companies combined with organizing a broad regional network of autonomous private/municipal fuel and energy conglomerates that produce inexpensive forms of fuel, heat, and electricity and are located as closely as possible both to raw material sources and to consumption locations.

The pressing problems at the current stage of development of Russia’s leading oil and gas companies are further growth in capitalization, profitability, and performance of production investments, reduction of expenses at all stages of production processes, and improvement of environmental indicators. In many cases, it is possible to achieve these goals by actively implementing the latest Russian breakthrough technologies to conserve energy resources and high-tech equipment, which have short payback periods. Conserving energy resources, a business necessity for profitability, is now a pressing requirement in light of the constant growth of energy prices and the looming shortage of electrical energy, which are hampering rapid development of most sectors of the Russian economy.

In turn, effective energy conservation, which is a powerful “hidden” investment resource, makes it possible to accelerate the resolution of the most important strategic national problems, such as achieving sustainable GDP growth, increasing national economic competitiveness, and assuring energy security. The international obligations that Russia assumed by signing the Kyoto Protocol and by its impending entry into the World Trade Organization also require increased energy and environmental efficiency in all areas of economic activity.

Currently, the most pressing obstacle to implementing a national energy conservation program for Russia’s oil and gas complex is the use of associated petroleum gas (APG). For quite a long time, oil companies considered associated petroleum gas to be a waste product of conditioning oil before it is pumped into pipelines. Nevertheless, a small part of the products extracted from APG is used as an energy fuel to service fields (in mini-generating stations and boiler rooms), and the rest is flared, releasing an enormous amount of carbon dioxide and soot into the atmosphere. According to data of the social organization Ecological Movement of Concrete Actions, in the past year, the volume of atmospheric pollution from flared APG was 12% of the country’s total volume of harmful emissions. Meanwhile, if associated petroleum gas were to be collected using gas capture systems, and if compressor stations were built and the APG were to be delivered by special pipelines to gas processing plants, it would be possible to produce many valuable products. In particular, these include dry stripped gas, whose product characteristics are close to natural gas, allowing it to be transported through Russia’s Unified Gas Supply System (UGSS) or used to generate electricity. Moreover, APG contains propane, butane, natural gas gasoline and natural gas liquids, which are key raw materials for the gas processing industry.

Russian Ministry of Energy statistics indicate that in 2009, Russian oil companies produced around 2 TCF of associated petroleum gas. The Sibur company, the main processor of associated gas, processed 494 BCF of APG and produced 353 BCF of natural gas liquids. At the same time, the Russian Ministry of Natural Resources and Ecology indicates that every year, companies write off around 47% of associated gas to process losses or use it for field needs, flare approximately 27%, and send only 26% for further processing, i.e., compression and gas fractionation. Today, many oil field license tracts lack metering systems, record-keeping documentation, atmospheric emission monitoring schedules, and a transportation infrastructure that would allow associated gas to be sent to gas processing plants. Independent experts estimate that the average level of APG recovery at Russian flaring systems was around 70–75% in the past year (that is, 25–30% of the APG, or around 530–706 BCF of gas, was flared). Russian Ministry of Natural Resources and Ecology experts have calculated that Russia loses around 139.2 billion rubles every year due to APG flaring alone, although the total benefit from APG processing in the country could amount to 362 billion rubles per year.

According to Sibur company data, only 24% of the total volume of APG produced is now sent for gas fractionation, which involves separating the liquid fraction or natural gas liquids from unstable hydrocarbon gases or condensates. In turn, only 42% of the total volume of associated gas sent for processing comes out as natural gas liquids and liquefied gases, and the remaining 58% is either used as fuel, or is exported and used for the same purpose. It turns out that, after all these transformations, only 10% of the total volume of APG produced in Russia is used to create chemical products with high added value. It can thus be concluded that the volume of APG involved in the production of expensive products in Russia is still too low. Incidentally, the US captures 97% of APG, and Norway completely prohibits flaring of associated gas.

Russia is already taking certain steps in this direction. For example, the long-awaited government decree freeing the price of APG sent to gas processing plants met the approval of the oil and gas community. However, this step fell far short of resolving the problems of the APG market. So far, the economy of projects depends greatly on the price of dry stripped gas, which is regulated by the government and still remains at a low level. To a certain extent, the freeing of the APG price eliminated some investment risks, but it did not in and of itself radically increase the attractiveness of investment in projects. Oil companies still face problems with delivering dry stripped gas separated from APG to the Unified Gas Supply System. Another factor that negatively influences the profitability of projects to collect and transport APG is the enormous distance between the fields developed by oil workers, gas processing plants, and petrochemical plants, which are frequently located in another part of the country. The number of pipelines for transporting gas condensate in Russia are all too few; for example, only a small transport line connects Tobolskneftekhim with the Sibur gas processing plants. For the most part, therefore, natural gas liquids have to be transported in railroad tank cars, and this greatly increases costs.

Unfortunately, there are complex systemic obstacles on the road to an efficient and comprehensive solution of this problem, but it is encouraging that the Russian government is now taking decisive steps to solve them. On February 13, 2008, the Public Council of the Russian Federal Service for Environmental, Technological, and Atomic Oversight approved a new version of a draft Russian government decree, “On Measures to Reduce Atmospheric Air Pollution Caused by Combustion Products of Flared Associated Gas,” whose provisions create real incentives for oil companies to develop technologies for collecting APG with the goal of separating valuable petrochemical products. On March 26, 2008, a government committee on the fuel and energy complex met in Moscow and thoroughly examined issues of APG recovery. Proposed measures included: creating an effective gas control system, implementing stricter licensing, and even substantially increasing environmental fines for exceeding limits on atmospheric emissions of harmful substances as a result of flaring gas. The meeting set the clear goal of increasing the volume of associated petroleum gas used to 95% by 2011. Companies that take real steps to utilize APG will receive preferential access to gas transportation networks and energy infrastructure. Duties on the export of propane/ butane fractions or liquefied petroleum gas (LPG) produced as a result of processing associated petroleum gas will also be abolished (currently, the export of LPG is subject to a duty pegged to the price of Urals-grade Russian oil on world markets). Thus, the government is striving to increase the attractiveness of investments in the APG segment in various ways.

Implementing government decisions to increase the efficiency of APG utilization has, in turn, required serious efforts on the part of Russian oil and gas companies to develop and implement their own corporate programs. In particular, starting in 2008, Gazprom expanded its research program to include measures that will allow elaboration of optimal engineering solutions for APG utilization, so as to increase the degree of APG use at the company’s fields to at least 95% by 2011. A Gazprom Executive Board resolution dated January 22, 2009, “On the Prospects for Developing and Introducing Gas and Energy Conservation Technologies and Their Influence on Optimizing the Fuel and Energy Balance Sheet of the Russian Federation” clearly confirmed the course that the company had set toward high APG recovery in all corresponding production units. Implementation of decisions that were made included having its subsidiary Gazprom Neft successfully implement its own program, “Utilizing and Increasing the Efficiency of Use of APG.” In 2008–2010, this program involves investing 17.6 billion rubles in projects to utilize associated petroleum gas. Of this sum, more than 12 billion rubles will be earmarked for construction of gas collection networks and gas processing capacity, and around 5 billion rubles will be spent on development of its own generating capacity. The remaining 600 million rubles or so will be used to audit existing resources for APG recovery. The company plans to build new gas pipelines from the Yety-Pur, Mereto-Yakha, North Yangtinsky, Chatylkinskoye, Kholmisty, South Udmurt, Ravninnoye, and Vorgenskoye fields, and also from the Urmanskoye and Shinginskoye fields. Moreover, in 2008–2010, Gazprom Neft built four gas-turbine and two gas-piston power stations, and in the past year the company spent more than 5.5 billion rubles to increase the efficiency of associated gas use.

Positive examples set by other companies can also be cited. RN-Purneftegaz (a subsidiary of Rosneft) invested more than 600 million rubles to implement the first stage of an APG recovery program that should increase the company’s associated gas recovery to over 90% on the basis of 2010 results. The TNK-BP company invested $2 billion in the construction of a gas collection network and other measures to recover APG, and the average APG recovery level is now greater than 76%. Surgutneftegaz, Tatneft, Bashneft, and many other oil companies are also making determined efforts to achieve high APG recovery figures.

LUKOIL is successfully implementing its “Associated Petroleum Gas Recovery Program for 2007–2016.” The program provides for increasing associated gas recovery at company enterprises from 75% to 95% over 10 years. New projects will recover 100% of associated gas. The tentative increase in gas production will amount to more than 198 BCF per year. In addition, the company is planning to build gas-piston and gas-turbine power stations with a total capacity of more than 400 MW in remote regions that are short of energy. The largest projects will be carried out at the Tevlin-Russkinskaya and Vat-Yëgan fields in the Khanty-Mansi Autonomous District, and also at South Khylchuyu field in the Nenets Autonomous District. The first of these went online in December of 2007, comprising a 72-MW gas-turbine power station at the Vat-Yëgan field. This is the largest facility of its type in the Khanty-Mansi Autonomous District. As fuel, the station uses associated gas produced at the fields of the Kogalymneftegaz oil production enterprise to operate six gas-turbine engines that, in turn, drive six gas-turbine generating units. The design of the gas-turbine engines is based on the gas generator of the aircraft engine installed on Russian Il-96, Tu-204, and Tu-214 airplanes, while the power station’s long-service-life power reducer was developed and manufactured by the Kirov-Energomash Plant. Every year, the power station consumes 4.2 BCF of associated petroleum gas that in turn makes production capacity at the Lokosovsky Gas Processing Plant available to process gas from newly opened fields. In August 2008, LUKOIL–Western Siberia brought a new 72-MW power station online at the same Vat-Yëgan field. Earlier, the Perm Motor Works had delivered six GTU-12 gas turbine units to the station; these had been developed on the basis of the fourth-generation PS-90A aircraft engine, which has an efficiency of 33.7%. An agreement is now being implemented to deliver another eight power units for LUKOIL–Western Siberia, under which two power stations having a total capacity of 48 MW will be set up at the Tevlin-Russkinskaya and Pokachëva oil and gas fields. In accordance with the program mentioned above, LUKOIL also plans to build a series of gas energy complexes that will provide a reliable supply of electrical energy for oilfield production facilities and will substantially increase the volumes of associated gas recovered.

In January 2010, the LUKOIL Executive Board approved an “Energy Conservation Program at Company Enterprises in 2010 and the 2010–2012 Period.” It presents energy conservation measures for 48 organizations of the LUKOIL Group in such business sectors as oil and gas production in Russia, gas processing, refining in Russia and elsewhere, petrochemistry, supply of petroleum products to Russia and other countries, power generation, and transportation. In particular, the document calls for the optimization of production processes and the introduction of new energy efficient technologies and equipment. In 2010, pilot projects were undertaken to redesign formation pressure-maintenance system pumps, to broadly introduce valve drives in centrifugal and screw pumps, and to supply energy for production based on renewable energy sources and on combined thermal and electrical energy sources. Successful implementation of this conservation program saved LUKOIL around 700 million kWh of electrical energy, more than 320,000 Gcal of thermal energy, and almost 57,000 tons of boiler/furnace fuel equivalent in 2010. In monetary terms, energy conservation measures saved the company on the order of 2.166 billion rubles. In 2010–2012, implementation of the Energy Conservation Program will allow the LUKOIL Group to save more than 2.35 billion kWh of electrical energy, more than 970,000 Gcal of thermal energy, and almost 235,000 tons of boiler/furnace fuel equivalent. In monetary terms, the company plans to save on the order of 9.203 billion rubles over three years.

Oil companies are now faced with a choice: either build their own gas processing plants, or create joint ventures with Sibur, the primary consumer of natural gas liquids recovered from associated gas. It is obvious that creating one’s own gas processing capacity is a capital-intensive process requiring large investments to construct pipelines and gas processing plants, and to set up a product processing and resale system, and therefore most Russian oilmen prefer to share the expenses with gas chemists. Experts estimate that Sibur’s independent investment projects and joint investment projects with oilmen will allow the holding company to increase its APG processing volume to 777–848 BCF by 2011.

Experts estimate that in 2007, Russian oil companies spent around 20 billion rubles for these purposes, and that another 100 billion rubles of investment would be required over the next two years. On the whole, implementation of corporate programs substantially increase the purposeful use of produced raw hydrocarbons in Russia, minimize environmental limitations, ensure uninterrupted energy supply to oil production facilities, lower tax risks, and increase revenue derived from selling additional volumes of APG and its processed products.

Energy Cooperation in the CIS Framework

A highly successful roundtable dedicated to problems of economic cooperation among CIS member countries was held on June 17, 2010 as part of the annual St. Petersburg Economic Forum. The roundtable participants reiterated that energy is one of the most important areas of economic development for CIS countries and that it plays an enormous role both in ensuring the normal function of all industries and in enhancing the operation of public agencies and the quality of life. The CIS Presidential Council had previously designated energy cooperation as a key area of interaction among CIS member nations on October 10, 2008.

Around the same time, several biased commentaries were once again published in the Western media regarding alleged crises in the CIS, including in the energy sector. But was this really the case?

The experience of leading industrialized countries, in particular of Western European nations that have made serious efforts in recent years to create competitive energy markets within the European Union, shows that the policy of regionalizing energy markets is viewed as an important prerequisite for the energy industry’s successful future development and once again underscores how extremely difficult it is today for one country, even one with a substantial energy resource base, to ensure its energy security when isolated from global integration processes in the fuel and energy sector.

An impartial analysis of the current state of energy cooperation between Russia and two of its CIS partners, Kazakhstan and Azerbaijan, reveals that the energy sector is one of the most significant and promising aspects of their productive cooperation.

As a member of the Foreign Investors Council of the President of the Republic of Kazakhstan, this author can say that successful and mutually beneficial interaction between Kazakhstan and Russia can clearly be seen in several large projects in the energy sector. One area of significant importance in the development of the oil and gas transport infrastructure between the two countries is their participation in the Baltic Pipeline System, which will make it possible to export oil from the Timan-Pechora oil and gas province and the Western Siberia and Volga-Urals regions, along with oil from CIS countries—principally Kazakhstan—via the Baltic port of Primorsk. In addition, the two countries are making joint efforts to efficiently utilize transit potential, in particular by increasing the carrying capacity of the Atyrau–Samara pipeline to 28 million tons of crude per year. Other notable areas of cooperation include a promising oil and gas condensate field within the Kurmangazi structure, which the Kazakh national oil and gas company KazMunayGas is developing jointly with Russia’s Rosneft; the organization of parallel operations between the energy systems of the two countries; the establishment of a joint venture on the basis of the Ekibastuz-2 State Regional Power Station; and many other potential business initiatives.

The project to develop the Karachaganak oil and gas field is particularly noteworthy. One of the largest in the world, the Karachaganak field was discovered in western Kazakhstan in 1979. The field covers an area of 173 square miles and has recoverable reserves of 2.4 billion barrels of oil and 16 TCF of natural gas. Field development intensified in 1995 after the Kazakh government signed an agreement on production-sharing principles with British Gas and Agip. In August 1997, Texaco purchased a 20% stake in the project from British Gas and Agip, which now each hold a 32.5% interest in the field. Gazprom transferred its 15% stake in the project to LUKOIL in November 1997. The investors established a joint operating consortium called Karachaganak Integrated Organization (KIO), which is headquartered in Aksay. A final Production-Sharing Agreement (PSA) was signed in November 1997 and took effect on January 27, 1998. The PSA envisions the Karachaganak field being developed over a 40-year period ending in 2038. A total of $160 million was invested in the project from various sources during the project’s first, preparatory phase from 1995 to 1997. Phase Two (1998–2003) required $3.5 billion in investment and increased liquid hydrocarbon production to 210,000 barrels per day by mid-2004. By that point, the Karachaganak project was independently generating its own free cash flow. LUKOIL’s share in production currently amounts to 15.3 million BOE, but this figure is expected to increase to 22 million BOE by 2010. The project’s high level of efficiency can be attributed to the sale of gas condensate via the Caspian Pipeline Consortium (CPC) system following the opening of the 395-mile Karachaganak–Bolshoy Chagan–Atyrau connecting pipeline. Gazprom and the Karachaganak consortium are implementing an agreement in this region to set up a joint venture that would annually ship up to 530 BCF of Karachaganak gas to the Orenburg Gas Processing Plant.

The Turgai Petroleum joint venture, which was set up under equal ownership by LUKOIL Overseas Holding and Canada’s PetroKazakhstan, is developing the northern section of the Kumkol field in Kazakhstan’s Kyzylorda Region. The field’s license area exceeds 57 square miles. Having produced 3.9 million tons of oil and 5.1 BCF of gas last year, the project is already providing a steady supply of crude hydrocarbons. The field has residual reserves of 41 million tons. The 110-mile Kumkol–Jusali oil pipeline has been operating successfully for five years, shortening the western export route by 745 miles and making it possible to export crude hydrocarbons via the CPC system. Facilities have been built to process and treat associated gas, and a gas turbine power unit with generating capacity of 55 MW has also been put into operation. This project allows 6.3 BCF of associated gas to be utilized each year and provides a reliable source of inexpensive electricity for the development of hydrocarbon fields.

According to the agreement between LUKOIL and KazMunayGas, the Russian oil giant has a 50% stake in the PSA for the Tyub-Karagan section in the Kazakh part of the Caspian Sea. This section covers an area of 450 square miles and is located 25 miles northwest of the port of Bautino at a water depth between 23 and 39 feet. The section has projected resources of 472 million TCE, including 357.6 million tons of oil. If commercial hydrocarbons are discovered, total expenditures on both projects could exceed $3 billion.

In addition, KazMunayGas and LUKOIL Overseas Holding set up a joint venture called Atash to drill an exploratory well as part of a contract for the geological exploration of the Atash block, which covers an area of 3,243 square miles and is located 50–53 miles from Bautino at a water depth of 23–115 feet. Atash has projected resources of 274.3 million TCE, including 156.2 million tons of oil. Other promising structures could be discovered in the eastern part of the block following additional exploratory operations.

LUKOIL’s works in progress also include projects to develop the Alibekmola, Kojasay, Karakuduk, North Buzachi, and Arman hydrocarbon fields as well as options for the acquisition of two exploratory blocks in the Kazakh section of the Caspian Sea: South Jambay and South Zaburin. These fields have 269.6 million barrels of proven and probable hydrocarbon reserves.

LUKOIL is the driving force in the energy dialogue between Russia and Azerbaijan and has made a significant contribution to several important projects. The Russian oil company’s largest project in Azerbaijan is the development of the Shah-Deniz gas-condensate field, which is located offshore about 62 miles south of Baku on the Caspian Sea shelf, at a water depth of up to 1,200 feet. The contract area covers 332 square miles and has recoverable reserves of 22 TCF of gas and more than 110 million tons of gas condensate. Azerbaijan enacted a law on October 17, 1996 ratifying an agreement for the exploration, development, and production sharing of Shah-Deniz field. At present, the international consortium members are BP (the project operator, with 25.5%), Statoil (25.5%), the State Oil Company of the Azerbaijan Republic (SOCAR) (10%), TotalFinaElf (10%), NICO (10%), and TPAO (9%). After acquiring the LUKAgip joint venture in January 2004, LUKOIL Overseas Holding increased its stake in the project to 10%. With the development of the Shah-Deniz field, LUKOIL increased natural gas production in Azerbaijan from 49 MMCF in 2006 to 11.3 BCF in 2009, while oil and gas condensate production grew from 330 tons to 97,000 tons.

Another important project is the development of the potential D-222 Block, a part of the large Yalama area, the most promising structure in the northeastern Caspian Sea, roughly equal parts of which are located in the Azerbaijani and Russian sectors of the Caspian, about 18 miles offshore. The water depth near the structure ranges from 260 to 2,300 feet.

The contract to develop this block was signed on July 3, 1997 and ratified on December 10 of the same year. Investment in the project is estimated at $2 billion. According to our estimates, the block has reserves of roughly 800 million barrels of oil and 1.8 TCF of gas. LUKOIL holds an 80% stake in the project, while SOCAR has a 20% interest. Contractual obligations called for the Russian oil company to drill two exploratory wells in the D-222 block. Drilling of the first exploratory well began in October 2004 and ended in June 2005. Unfortunately, drilling did not reveal any hydrocarbon reserves, although experts are hopeful that a second well will produce positive results.

LUKOIL has also made significant contributions to the development of the Azerbaijani fuel market. In 1995, the oil giant opened the first gas station in Baku that complied with international technical, environmental, and service standards. By 2008, LUKOIL was successfully operating more than 20 gas stations in Azerbaijan, in addition to one of the country’s most modern gas tank batteries. The high level of cooperation between Baku and LUKOIL, which has invested more than $1 billion in the Azerbaijan economy, provided an impetus for the Russian company to expand its operations in Georgia and Turkey. LUKOIL currently accounts for a considerable share of the fuel markets of these countries in addition to the bunker business in the Black Sea.

Russia’s energy relations with Uzbekistan and Turkmenistan have also been developing productively as of late. On November 29, 2007, LUKOIL Overseas Holding and Uzbekneftegaz commissioned the Hauzak gas field as part of a PSA on the Kandym-Hauzak-Shady-Kungrad project. Hauzak field, which is part of Dengizkul field, is located on the shore of Dengiz Lake in the Bukhara Region in southwest Uzbekistan about 118 miles from the city of Bukhara near the Turkmenian border. The field could have a maximum annual production level of roughly 388 BCF of natural gas (production is expected to peak in 2012–2013), giving LUKOIL one-fifth of overall gas production in Uzbekistan. The project could ultimately result in total output of more than 7 TCF of gas.

Existing intergovernmental agreements between Russia, Kazakhstan, Azerbaijan, Uzbekistan, and Turkmenistan emphasize enhanced cooperation in the oil and gas sector as well as coordination of the fundamental restructuring of their national economies. The key benefit of successful energy cooperation between Russia and its individual CIS partners is the opportunity to achieve total energy self-sufficiency and to substantially expand the export potential of both countries. Other important aspects of such cooperation include the establishment of the appropriate legal frame-work in the partner countries to promote development of trade and economic ties in the energy sector, conditions for free and uninterrupted transit of energy resources, and implementation of coordinated customs, tax, and tariff policies in branches of the energy sector.

Russia and its CIS partners could also enhance cooperation in such promising areas as the more efficient use of transit potential, the development of transportation infrastructure, and the expansion of export opportunities for the shipment of oil and gas resources to third countries. Kazakhstan has started building its segment of the Western Europe–Western China International Transit Corridor (overall length 5,247 miles, including 1,732 miles in Kazakhstan). The Kazakh segment of the corridor will bypass the southern regions of the country and eventually enter Russia at Aktyubinsk. According to the 2007–2011 program for the further development of the Khorgos International Border Cooperation Center (Kazakhstan-China), the Kazakh city of Aqtaw is viewed as a strategic point within the unified transportation and logistics system of the Central Asian Transport and Industrial Corridor, which will connect with the North-South and Transsib transport corridors in central Russia.

Today, both the price structure and the geopolitical structure of the global oil market are changing. Key centers of gravity are currently being set up in Northeast Asia, where multilateral cooperation in the energy sector is set to develop. Under these conditions, Russia, Kazakhstan, and Azerbaijan can play key structural roles in the establishment of multilateral Eurasian energy cooperation. Successful cooperation between these countries in the transportation of oil and gas resources to the West can and should be complemented by the joint export of hydrocarbons to the dynamically growing markets of East Asia—above all, China. It is clear that Russia, Kazakhstan, and Azerbaijan are of strategic importance to China thanks to their enormous hydrocarbon reserves, their close proximity to the Chinese border, and the undeniable convenience of transporting crude hydrocarbons.

The expansion of energy cooperation between Russia and its CIS partners naturally does not bind these countries to any harsh restrictions that infringe on their sovereignty or prevent them from participating in other international oil and gas projects. On April 24, 2008, the Kazakh Parliament ratified an agreement with Azerbaijan that envisions the accelerated creation of a Kazakh-Caspian hydrocarbon transportation system that will provide 25 million tons of oil supplies per year to the Baku–Tbilisi–Ceyhan pipeline system. Tankers will deliver Kazakh oil to Baku from the Port of Aktau.

So-called alternative oil transportation projects (the Baku–Tbilisi–Ceyhan and Odessa–Brody oil pipelines, etc.) have met with a mixed reception in the Russian political and business community. Some experts have gone so far as to call these routes an implicit anti-Russian move by Kazakh and Azerbaijani authorities. In this author’s view, however, these projects have several significant and constructive components to intensify mutually beneficial Eurasian cooperation. Kazakhstan and Azerbaijan both have an objective need to build new export oil pipelines outside Russian territory so that they can diversify export flows of crude hydrocarbons and thereby raise the overall level of energy security both within particular regions and in the world as a whole.

The creation of a common energy market in Russia and the CIS will promote the development of mutually beneficial economic relations in the energy sector, saturate the domestic market with inexpensive types of energy resources, cover consumer demand for such products, and expand opportunities to export energy resources to third countries. Some major achievements have been made here. President Medvedev paid his first state visit to the Republic of Kazakhstan on May 22–23, 2008. During talks with Kazakh President Nursultan Nazarbayev, the two leaders confirmed plans to form a joint fuel and energy budget for the period until 2020 as part of strategic bilateral cooperation. On the basis of this budget, the two countries will develop joint approaches to the use and development of an energy resource transportation system. The two countries also have a unified position on the issue of expanding CPC capacity from 35 million tons of oil per year to 74 million tons. The pipeline’s capacity is to be increased in two phases prior to 2012. In addition, as part of plans to develop the oil industry, another 19 million tons of Kazakh oil are to be shipped to fill the yet-to-be-completed Burgas–Alexandropol oil pipeline, which will substantially increase crude hydrocarbon supplies to southern Europe. For its part, LUKOIL has announced plans to significantly boost investment in Kazakhstan, and the company’s board of directors has set a goal of increasing hydrocarbon production in Kazakhstan to 8.8–11 million TOE per year by 2010.

Who Is Creating the Myth of Russian Energy Expansion?

The European Union currently accounts for 52% of Russian exports, and energy commodities make up the overwhelming majority of this volume. For instance, Russia provides roughly 20% of all primary energy resources consumed by Germany, and more than 35% of the natural gas and over 30% of the oil consumed in Germany comes from Russia.

It is therefore clear why the energy industry has become one of the top priorities of the EU’s internal policy and why its relations with Moscow have been pushed to the top of the agenda. At present, Russia is building relations with the EU in the framework of a mutually beneficial energy dialogue which was launched at a summit in October 2001. In practical terms, Russia and the EU have managed to reach an agreement on the cancellation of recommended import limits previously established by the EU for Russia (no more than 30% of energy imports from one external source), to link the subject of the dialogue with a roadmap for achieving their objectives, and to provide an overall assessment of several cooperation projects. Together they set up the Energy Technologies Center, where a promising effort is under way to utilize associated gas, refine heavy grades of crude, build mini-hydropower plants, and use clean coal-burning technology. The Center is to play a key role in the realization of a new Russia-EU joint energy conservation initiative. The first projects of this kind have been implemented in Kaliningrad, Arkhangelsk, and Astrakhan regions.

Unfortunately, however, nettlesome hindrances in the form of artificial barriers have periodically blocked the path to mutually beneficial energy cooperation between Russia and the EU.

On February 5, 2008, US National Security Agency Director John Michael McConnell announced in his annual report to Congress that Russian energy expansion was occurring at a threatening pace. McConnell argued that Russia, whose financial capabilities were growing as a result of windfall oil revenue, aspired to gain control over the energy resources and the transportation network from Europe to Eastern Asia. He called Moscow’s potential economic “threat” one of the most serious challenges for the US and said it was on a par with terrorism, the spread of nuclear weapons, and the vulnerability of computer networks.

It is little wonder that not long after this statement was made one of the most respected US newspapers, The Wall Street Journal, published a headline with a free interpretation of his words titled “In Gazprom’s Grip.”

In the European press, unfortunately, the tone of publications under the general slogan “The Russians Are Coming!” was even more alarming. The European community essentially ignored the Russian government’s statements that the use of money from the country’s Stabilization Fund and Future Generations Fund was a general strategy for diversifying investments and not an attempt to buy up any strategic assets in Europe. The Western press interpreted Russia’s refusal to ratify the Energy Charter as some kind of secret plan to achieve energy dominance throughout the continent. It could very well be said that EU countries had never been so concerned before about the alleged weakening of their energy security because of a growing dependence on crude hydrocarbon supplies from Russia. Even the most common market occurrences, such as Gazprom’s hike in natural gas prices for Ukrainian consumers this year, was presented in the EU press as an instrument of harsh political pressure on Kyiv. And all of this was happening despite the fact that Russia had been consistently reproached in the past for selling natural gas to CIS countries at prices that were too low.

Unfortunately, under the influence of a massive media campaign, many people in the EU began to perceive Gazprom and all other Russian companies as foreign policy tools of Moscow and the efforts of these companies to expand business on EU markets as a kind of aggressive foreign economic policy. At the end of 2007, the Hamburg-based Europaeische Verlagsanstalt publishing house released a book by German journalist Gemma Pörzgen titled Gasprom. Die Macht aus der Pipeline [Gazprom: Pipeline Power]. This was the first work of this kind in Germany that provoked a mainstream debate about the possibility of foreign state-owned companies having wide access to the economies of EU countries, and it captivated European politicians and businessmen. For Russian readers, this book revealed no secrets or sensational details at all about Gazprom or the “motives” of the Russian energy policy. At the same time, it visibly and vividly illustrated the main stereotypes and perceptions, ingrained in the mass public consciousness of various groups and levels of European society, of how Russian companies purportedly conduct their foreign operations. Unfortunately, the psychology of double standards was strongly reinforced here—the flow of foreign capital into the Russian economy is perceived as a positive development and described as Russia’s integration into the global community, while the investments of Russian companies in various industrial branches of other countries are sometimes viewed negatively and labeled as threatening “Russian expansion.”

At present, with their energy security under threat, European policymakers have begun to understand that the position of energy suppliers, particularly Russia, has strengthened to a certain degree, which, in their view, has led to a sharp decline in competition on energy markets, heightened political vulnerability in EU countries and ultimately, led to an undermining of the rule of law. Appeals have been increasingly made in the foreign press for protection from Russian “energy aggression” by any means necessary, which led to a kind of psychology taking hold in the West of rejecting Russian business and prompting growth of protectionist sentiment throughout Europe. It is not surprising that the European Commission last year proposed dividing companies operating on the EU market into production and transportation/distribution divisions—a move that, if approved, would block Gazprom from entering the EU energy distribution market.

It is obvious that the energy policy of leading countries is invariably based on a sound and sensible strategy that includes both an economic ideology distinguished by long-term stability and specific targets for the development of branches of the national fuel and energy industry.

The events of the last decade have shown that the global crude market is susceptible to serious market fluctuations, from $9 per barrel in 1998 to $111 per barrel in March 2008. Prominent experts have voiced the unanimous opinion that energy prices will continue to grow steadily while remaining highly volatile. This will clearly have an inevitable negative impact on the economic development of most countries—both importers and exporters of energy resources. It is therefore extremely important for Russia to maintain stable and long-term relations with its foreign partners, given its current economic structure and considerable dependence on crude commodity markets.

With the acceleration of globalization processes, the world is not becoming simpler, but rather more complicated and tougher. An unbiased observer can see how the sovereignty of individual countries has been destroyed by those hiding behind the slogans of freedom, democracy, and an open society, and sometimes even through the use of force, and also how the policy of protectionism and government intervention in the economy is strengthened under vibrant rhetoric about the freedom to trade with and invest in various countries around the world. Oil and gas interests are also clearly present in many conflicts, foreign policy moves, and diplomatic maneuvering.

Russia strongly rejects accusations from the West that it is using raw materials as a tool of foreign policy pressure. No one can cite a single example of Russia using its natural resources to apply pressure in its foreign policy.

The Russian president and members of various levels of government have stated on several occasions that Russia is not planning to use oil and gas as a political weapon, or to allocate its oil and gas revenue for strategic investments with the aim of taking over any branches of foreign economies. Allegations that Russia has of late been conducting an aggressive energy policy in the global arena have no grounds whatsoever. Global energy security not only implies security of supplies, but also security of demand. This point was noted in the concluding documents of the G8 Summit in St. Petersburg in 2006, which means that this principle is shared by leading industrial powers.

Russia is fully accountable for its ability and responsibility to strictly fulfill its obligations to deliver energy resources to Europe, as well as for the need to reliably guarantee such supplies. Russia is a dependable partner for the entire international community when it comes to addressing global problems, including mutually beneficial cooperation in all areas: security, science, energy, and the climate. Our country is interested in participating very actively in global and regional integration processes; cooperating closely in trade, economics, and investment; and promoting advanced technologies and implementing them in everyday life. All of these activities are in keeping with Russia’s strategic goals.

It should be recognized clearly that the international development plans of Russian companies are based on generating business revenue and not on any expansionist political aspirations. They seek to ensure that investors get the biggest return on their company investments in a market environment where competition is very high. When Russian companies have to deal with a “policy of containment,” in most cases this means that there is often a hidden desire to subject them to improper laws or unfair market competition. Fears in the EU that the dependence of Western nations on Russian energy supplies is growing too rapidly are entirely unfounded, since Gazprom, LUKOIL, and other Russian companies build relations with their European partners on market principles based on mutually beneficial interdependence. Hence they seek to ensure the same degree of reliable security for crude hydrocarbon supplies to both Western countries and all EU nations. It must be understood that, given the falling production in Western Siberia, the logic of globalization processes suggests that if Russian companies do not start actively investing funds in new oil production regions and implementing projects abroad, Russia’s role and influence in ensuring global energy security could decline substantially.

Russia is interested in strengthening global energy security in every way possible, particularly in Europe, and a variety of options for transporting crude hydrocarbons could be of practical value. It is clear that the transportation infrastructure for supplying energy resources to Europe must be expanded. Problems with European energy security can only be effectively resolved if the balance of interests between consumers and producers of energy are considered, along with the interests of transit countries. Therefore, the efforts of all parties interested in such a resolution should be directed towards finding this balance.

As for the problem of diversifying energy supplies to Europe, which has become a hot topic in the EU, it is Russia that is currently working on a practical solution. It is our country that is diversifying oil and gas transit routes to Europe by implementing international projects such as the construction of the Burgas–Alexandropol oil pipeline and the extended South Stream and Nord Stream gas pipelines.

The creation of these new transit routes considerably increases energy security in the EU, strengthens stability, and presents new opportunities for delivery of supplies to European consumers. In addition, the expansion of transportation infrastructure in one country does not mean that Russia’s cooperation with other transit nations will be reduced or phased out in any way.

It should not be forgotten that there was a serious battle among European nations to host the new transportation capacity being built by Russia. Indeed, the presence of such facilities on the territory of any country undoubtedly raises its political and economic importance and generates budget revenue, among other things.

On January 18, 2008, Russia, Bulgaria, and Greece signed a trilateral agreement on the creation of an international company to build the Burgas–Alexandropol oil pipeline. Russia’s Burgas–Alexandropol Pipeline Consortium LLC (comprised of Transneft, Rosneft, and Gazprom Neft) owns 51% of this new company. Greece’s 24.5% stake in the company is divided among a consortium comprising Hellenic Petroleum and Thraki (23.5%) and the Greek government (1%), while the other 24.5% is owned by the Bulgarian design company Burgas–Alexandropol BG, which, in turn, is owned by the corporations Tekhnoeksportstroy and Bulgargaz. Agreements between these companies stipulate that the Bulgarian and Greek governments must provide a favorable tax regime for the international company, while Russia, for its part, pledges to fill the new pipeline with oil. The 177-mile Burgas–Alexandropol pipeline will run through Greece and Bulgaria, and will significantly reduce the volume of crude transported by oil tankers through the congested straits of the Bosporus and Dardanelles. The tentative cost of the project is about €1 billion. The pipeline will be able to handle 17 million tons of crude per year in Phase One, 26 million tons in Phase Two, and 39 million tons in Phase Three, with the possibility of eventually boosting this amount to 55 million tons annually. Experts say the project has a clear economic logic and meets the pressing needs of European nations in accordance with their long-term demand for oil.

Greek Development Minister Christos Folias said that the Burgas–Alexandropol oil pipeline will be highly beneficial to the citizens of Russia, Greece, and Bulgaria in addition to their EU partners. He stressed that “a new era has begun for the three participating countries—an era of economic cooperation, common political strategy, and good neighborly relations.... Hard work is still being done to realize the dream belonging to the people we represent.... The citizens of our countries—in addition to our partners in the European Union—will ultimately be the ones to benefit from these major joint efforts.”

The joint implementation, with Russian companies, of energy projects for natural gas transportation is also of paramount importance in ensuring Europe’s energy security. It is now obvious that existing pipelines do not have sufficient capacity to handle the new volumes of Russian gas. A framework agreement was signed in 2005 to build the Nord Stream gas pipeline. The shareholders in the project’s operating company, Nord Stream AG, are Gazprom (51%), Germany’s Wintershall Holding and E.ON Ruhrgas (20% each), and the Dutch company N.V. Nederlandse Gasunie (9%). This gas pipeline will create a completely new route for transporting natural gas, which will not only significantly raise the reliability of fulfilling long-term contracts, but will also diversify gas supplies from Russia to Europe. The entire route of the Nord Stream pipeline was designed so as not to pass through sites at which chemical weapons from World War II are stored. A portion of the proposed pipeline runs along the bottom of the Baltic Sea, and in addition to avoiding chemical weapon storage facilities, the route avoids environmentally sensitive zones, military sites, important navigational routes, and other special areas that are used for economic or recreational purposes. At present, a detailed evaluation of the pipeline’s impact on the environment is being compiled prior to the start of construction. The pipeline will be built to the strictest environmental standards, which will ensure the ecosystem of the Baltic Sea is not disturbed. Nord Stream will connect the Russian shore near the city of Vyborg with the German shore near Greifswald. The underwater segment will be about 745 miles long. Construction began on the 570-mile land segment in Russia in December 2005, and construction of the first offshore segment of the pipeline began on April 9, 2010. President Medvedev, German Chancellor Angela Merkel, Dutch Prime Minister Jan Peter Balkenende, and other government officials took part in the ceremony marking the start of construction outside Vyborg. During his speech, Medvedev stressed: “Nord Stream is a key link in ensuring global and European energy security. It is an extremely important and system-wide project in the Russia-EU energy dialogue, as clearly evidenced by its special status as a Trans-European Energy Network.” The project’s status as a Trans-European Energy Network dates from December 2000, when the European Commission made the designation, which was reconfirmed in 2006, recognizing Nord Stream as a key project for creating an important cross-border transportation capacity to ensure Europe’s sustainable development and energy security.

Phase One of the Nord Stream pipeline, which will have a carrying capacity of 971 BCF of gas per year, is to be put into operation in 2011. The completion of Phase Two construction by 2012 will increase its capacity to 1.9 TCF.

The pipeline subcontractors reflect the broad international nature of this project. Italy’s Saipem is laying the offshore pipes, while Europipe produced 75% of the pipes and Russia’s United Metallurgical Company manufactured the other 25%. Nord Stream AG invested more than €1 billion in the production of pipe for Phase One of the pipeline. France’s EU-PEC PipeCoatings S.A. is handling the logistics of the project, including the pipe wrapping, as well as interim pipe transportation, loading, and storage. These services are worth an estimated €650 million. On June 19, 2010, Gazprom and Gaz de France Suez signed an agreement allowing the French company to join the Nord Stream project with a 9% stake.

The new gas pipeline has considerable importance for reliably meeting the European market’s growing needs for natural gas. Forecasts indicate that gas imports to the EU will increase by roughly 7 TCF over the next decade, or by more than 50%. By directly linking the world’s largest gas reserves in Russia with the European gas transportation system, Nord Stream will be capable of satisfying approximately 25% of this additional demand for imported gas.

Enhanced cooperation between Balkan countries and Russia in the creation of additional gas transportation corridors will enable this region to fully satisfy its demand for energy resources in the coming years, thus providing stable economic growth. The South Stream gas pipeline, a large-scale joint project between Gazprom and Italy’s ENI, will play an important role in this process. Under the project, a gas pipeline will run from Russia to Bulgaria along the bottom of the Black Sea and carry gas through Bulgaria to the rest of southern Europe. One of the biggest advantages of this pipeline is that it will bypass problematic transit countries such as Ukraine and Belarus. The pipeline has a projected carrying capacity of 1.1 TCF of gas per year.

The South Stream pipeline, which is being built by Russia, Italy, Greece, Bulgaria, Serbia, and Hungary, is an extremely important transportation project for southern and central Europe that will provide a strategy for diversifying gas supplies. Total investment in the project is estimated at more than $10 billion. The offshore segment of the gas pipeline will run along the bottom of the Black Sea from the Beregovaya Compressor Station on the Russian coast near the village of Arkhipo-Osipovka to the Bulgarian city of Burgas. The pipeline will be about 560 miles long and run at a maximum depth of more than 6,500 feet. The land-based segment of the pipeline will consist of two branches. One of them will run southwest, through Bulgaria and Greece and across the Adriatic Sea, to the Italian city of Brindisi, while the second branch will travel northwest through Serbia and Hungary. South Stream AG, an equally owned joint venture set up by Gazprom and ENI and registered in Switzerland in mid-January 2008, will be working on a feasibility study for the pipeline’s construction in 2011. Construction is scheduled to be completed in 2013.

At the signing of the project agreement in Sofia on January 18, 2008, Bulgarian Prime Minister Sergey Stanishev said: “Bulgaria’s interests in the project have been fully taken into consideration, since the company that is being set up to build and manage the pipeline on Bulgarian territory will have equal 50% ownership by each side.... Bulgaria’s involvement in this project will significantly enhance the country’s role on the energy map of Europe. And since Bulgaria will own a 50% share, its interests will not be violated under any circumstances, including with respect to receiving dividends.”⁹

A Russian-Serbian intergovernmental agreement on oil and gas industry cooperation was signed in Moscow on January 25, 2008, covering, among other issues, the construction of the Serbian segment of the South Stream gas pipeline system. The Serbian segment of the pipeline is to have a capacity of at least 353 BCF of gas per year. In addition, an underground gas storage facility with active capacity of at least 10 BCF is to be built on the basis of the depleted Banatski Dvor gas field 37 miles northeast of the Serbian city of Novi Sad. Serbia will earn some €100–200 million each year solely from the transit of gas across its territory.

Russia and Hungary signed an intergovernmental agreement to cooperate in the construction of the South Stream pipeline in Moscow on February 28, 2008, and Gazprom and the Hungarian Development Bank set up an equally owned joint venture to handle issues related to the pipeline. The Hungarian segment of the pipeline will cost the joint venture about €700 million to build. In a March 10, 2008 interview with Rossiyskaya gazeta, Hungarian Minister of Finance Janos Veres stated: “I would single out three important points in regards to the South Stream project. First, with the construction of the new gas pipeline, Hungary will acquire a new route by which it can receive gas. In the past, we received gas from Russia through only one pipeline that transited Ukraine. Now a gas pipeline will run to us from the south, through Serbia. This alone will diversify gas supplies for us, which is something on which our economy greatly depends. It will make gas supplies more secure for us. Second, a segment of the new gas pipeline to Europe will be built on Hungarian territory. Its construction promises to be extremely profitable. A state-owned company is to take part in the project on Bulgaria’s behalf, and its capital investments are expected to see a quick return and start generating profit for the treasury. Once the gas pipeline is put into operation, the country will start receiving duties for the transit of gas to Western European nations, which will also contribute to the treasury. Finally, in addition to the gas pipeline itself, the South Stream project envisions the construction of a large gas storage facility on Hungarian territory with capacity to store about 1 billion cubic meters [35 BCF]. An agreement on this issue has been signed. All of this means that, on top of previous volumes, Hungary will receive a substantial amount of new gas for storage in the near future. This, in turn, will only strengthen the country’s energy security.”

It should be emphasized that, on the whole, the Balkan countries were correct in their decision to step up cooperation with Russian energy companies and in their expectations of receiving real benefits from such cooperation. According to data published by Top Energy (the Balkan dispatch center), gas supplies to the Balkan countries increased 13.2% in 2007, while Bulgaria (Russia’s main partner in the region) purchased 4.7% more Russian gas. In addition, a record volume of Russian gas transited Bulgarian territory in 2007.

Gazprom CEO Aleksey Miller and OMV¹⁰ Chairman and CEO Dr. Wolfgang Ruttenstorfer signed a framework agreement in Vienna on April 24, 2010 concerning cooperation in the South Stream project within Austria, where the production rate is to amount to at least 177–353 BCF of gas per year. The document set forth the terms and timeline for Gazprom and the Austrian OMV oil and gas company to complete the Austrian segment of South Stream, and also established the principles and mechanisms by which the two parties will interact during the project’s pre-investment phase. In accordance with the agreement, Gazprom and OMV began making joint preparations in 2010 for a feasibility study on the Austrian segment of the pipeline, which will contain a detailed evaluation of all the project’s technical, legal, financial, environmental, and economic features and indicators. In addition, the two companies set up an equally owned joint project company that will handle the subsequent design, financing, construction, and use of the Austrian segment of the South Stream pipeline. As part of this project, OMV expects to receive additional natural gas supplies of some 70 BCF on a long-term basis.

Currently, a debate is ongoing in the European press about a few so-called alternative projects for gas supplies to the EU. The most prominent of these projects is Nabucco, which calls for a pipeline to be routed from the Caspian Sea region to Austria via Iran and Turkey at an estimated cost of $6.14 billion. An international consortium led by OMV is to build and operate the gas pipeline. Nabucco’s maximum carrying capacity is estimated at 1.1 TCF of gas per year. Turkey, Bulgaria, Romania, Hungary, and Austria have all expressed a desire to take part.

Leading energy experts have given an extremely skeptical assessment of the viability of this project. Commenting on Nabucco, André Mernier, secretary general of the Energy Charter Secretariat, said: “Implementing the project under uncertain circumstances in areas close to the Black Sea region is extremely difficult. In the present situation, it is very hard to predict when the problems of Iran and Iraq will be resolved, and so, given the heightened risk and high costs [of the project], it will be difficult to find companies that will invest in it. In addition, the region does not have sufficient natural gas reserves to implement the Nabucco project.”¹¹ This view was shared by Necdet Pamir, the general coordinator at the Center for Eurasian Strategic Studies, who said: “There clearly is not enough Iranian and Azerbaijani gas to implement the project.”¹² Pamir maintains the Nabucco pipeline will not be profitable without Russian and Turkmenian natural gas.

Looking at the situation objectively, it should be noted that Azerbaijan is only planning to reach a production level of 706 BCF of gas per year in 2012, and there is even greater uncertainty surrounding gas supplies from Iran. It appears that the EU has recognized this fact and has gradually begun to push back the schedule for the Nabucco project’s implementation, initially until 2011 and then to 2012. In February 2008, the Nabucco Gas Pipeline International consortium postponed the launch of the Nabucco gas pipeline by another year, until 2013. Not long after this, Gaz de France withdrew its bid to take part in the construction of the pipeline.

Ensuring global energy security is a complex and systemic problem that can only be resolved on the basis of close and mutually beneficial international cooperation that considers the interests of both the countries exporting crude hydrocarbons and the countries consuming the energy resources. In this regard, it is clear that a new agreement on Russian-European strategic energy cooperation is long overdue. This could be one of the most important components of anew Russia-EU cooperation agreement. The main issues that should be covered in this new document are: determining a mechanism to make long-term forecasts of energy resource demand so that Russia can coordinate the introduction of new production capacity in addition to infrastructure projects; developing a legal mechanism to ensure Russia and the EU make reciprocal investments in the energy sector; developing framework terms for the sale of energy resources; and defining the main parameters of energy resource transit. There are other issues, of course, including the lifting of unjustified barriers to trade and investment, as well as the assurance of preliminary consultations when a government considers making a decision on the energy sector that affects a partner’s interests. Russian oil and gas companies are respectful of EU regulatory laws and have expressed willingness to constructively take part in a discussion of sensible European Commission proposals that raise important issues not only regarding property, but also investment, price policy, and the security of crude hydrocarbon supplies. Moreover, if the parties are able to reach agreement on issues concerning the transit of energy resources and take the balance of interests into account, perhaps a legally-based Transit Agreement could be drawn up and passed as part of a new Cooperation Agreement. Other countries transiting crude hydrocarbons could later join such an agreement.

On the whole, Russia and the EU need more openness and predictability with regard to their national energy strategies, as well as the joint development of common rules and institutions to regulate the energy market. All of this will ultimately and undoubtedly contribute to stronger global energy security and a higher level of transparency and predictability in the global energy market, as it will balance the interests of all parties—energy resource consumers, producers, and transit countries. The implementation of these and other sensible proposals will make it possible to reach compromises on other similar complex issues concerning the sustainable development of the global economy as well as modern civilization.

Is There a Real Alternative to Oil Today?

Along with the problems of the world oil market, one of the most popular subjects discussed in the Russian and foreign media has become the possibility of a rapid reorientation of the world economy toward alternative forms of fuel based on nonfossil raw materials, in particular, the broad use of biofuel. There is no dispute that the development of renewable sources of energy simultaneously reduces the use of conventional sources of energy, and accordingly reduces the release of pollutants into the atmosphere. For example, adding only 10% bioethanol to common gasoline reduces atmospheric emissions from automobiles by 30–50%.

Of late, many different countries of the world are pinning great hopes on alternative sources of energy. Today, many European countries facing an impending energy deficiency have turned to developing an alternative energy system, betting on energy from the sun, wind, water, waves, and tides, as well as the production of biofuel. On the whole, the contribution of alternative energy sources in various European countries ranges from 5% to 10%, although by 2020 the European Union plans to increase its share to 20%, and to 40% by 2030. Japan hopes to produce 1.35% of its electricity from alternative energy sources by 2010, not counting geothermal stations or industrial hydroelectric plants. Egypt expects alternative energy sources to account for 14% by 2020. And so forth.

In 2006, US President George Bush’s ambitious national program “20 by 2010” set the country’s energy policy the goal of reducing automotive gasoline consumption 20% by 2010. Accompanying this was the loud slogan: “Big corn will replace big oil.” And earlier, in 2005, the US Congress passed the Energy Policy Act, which set the goal of increasing bioethanol production from 4 billion gallons in 2006 to 7.5 billion gallons in 2012. Such radical measures are explained by the necessity of reducing dependence on crude hydrocarbon imports and concern for the environment. In October 2007, the US Department of Energy published a progress report on the 20-year plan for strategic scientific research aimed at developing conventional and alternative energy. The original plan, dated 2003, listed 28 key types of research and set priorities and deadlines. The report said that bioenergy research was aimed at studying efficient ways of converting cellulose and other types of plant biomass into sugar, the primary feedstock for biofuel. Since January 2005, the number of operational ethanol production plants in the US has increased from 81 to 129, and another 80 are under construction.

In a speech on March 4, 2008 at the International Conference on Renewable Energy Sources, Samuel Bodman, United States secretary of energy, emphasized that American investment in biofuel energy had already exceeded $1 billion. Among key projects, he singled out $400 million in investments in three bioresource research centers, intended for five years. Moreover, Secretary Bodman mentioned a new joint project between the Department of Energy and the Department of Agriculture to carry out more than 20 studies in this industry at a total cost of $18 million. The main goal being pursued by the US in developing biofuel resources is to reduce the country’s gasoline consumption by 20% over 10 years, but making biofuel price-competitive with gasoline by 2012 is also important. All of this, the US administration feels, should substantially reduce harmful atmospheric emissions. Acknowledging that “a great deal remains to be done and this will not be easy,” Samuel Bodman expressed optimism about the prospects of this new direction in energy, stating that “the world is on the road to cleaner, more available, and safer energy, and biofuel will play the main role here.”

Along with starry-eyed optimism in forecasts about biofuel’s prospects in the world media, analytical articles began to appear in which the authors expressed very sober opinions about this issue, emphasizing that massive use of biofuel presented substantial global risks in very different areas and spheres.

A rapid and poorly thought-out transition to biofuel by the leading world powers could have negative consequences for the environment and well-being of the inhabitants of developing countries. A report to the United Nations Economic and Social Commission for Asia and the Pacific (ESCAP) published in March 2008 noted that many countries were, that same year, expecting food products to jump in price partly due to the increased use of grain and sugar cane for production of biofuel. “The rapid increase in the prices of food products will be the main problem this year,”¹³ said Shuvojit Banerjee, a representative of this commission. “And since it will apparently be impossible to stop the movement toward increasing biofuel production, the region will have to prepare for a long period of inflation due to higher prices for food products.”¹⁴ The commission called on the governments of Asian and Pacific countries to undertake additional measures to protect the poor from economic shock. Along these same lines, P. Chidambaram, India’s finance minister, declared that the use of agricultural products for producing biofuel was a blow to the poor, and called this “a sign of perverted priorities in some countries.... This is disgraceful and deserves condemnation.”¹⁵

Recently, the US national program to produce bioethanol from corn has been drawing more and more severe criticism in the press. Experts have calculated that grain ethanol requires a massive amount of agricultural land: replacing just 10% of American motor fuel with alternative biofuel would require a third of all cultivated land to be devoted to grain production. In 2006, 60 million of the 295 million tons of grain harvested were used for bioethanol production. This created obvious imbalances in agricultural production, and grain prices increased 50% over the preceding period. An increasing number of American farmers are taking advantage of government subsidies and planting industrial corn, and this in turn creates a shortage of animal fodder, which inexorably drives up the prices of meat products.

At the same time, whereas in 2005 the average price of a gallon of ethanol decreased from $2.00 to $1.55, the cost of corn, the basic raw material for its production, increased from $1.60 to $3.27 per bushel. Thus, biofuel producers ended up squeezed between decreasing revenue and growing expenses, despite generous federal subsidies on the order of 51 cents per gallon.

At first glance it would seem that massive use of biofuel, if we are to believe the claims of its proponents, should substantially reduce dependence on crude hydrocarbons, and consequently, demand for oil should sharply decrease. However, simple calculations show a different picture. Using current technology to process vegetable and grain crops into biofuel, the amount of energy spent on its production is only slightly less than the amount obtained from its energy content. This is readily apparent from analyzing the value of the EROEI (Energy Return on Energy Invested) coefficient, which reflects the ratio of the energy obtained from a resource to the energy expended for its derivation. (This only applies to industrial energy expenditures; sunlight and photosynthesis do not count.) If the EROEI is less than 1, then energy expenditures are higher than the energy extracted from the resource. Experts estimate that the EROEI for various agricultural crops processed into biofuel ranges from 0.7 to 3.2. Given such EROEI values, it turns out that the more biofuel is produced, the more conventional fuel is needed for its production. It is well known that biofuel production involves the combustion of coal or residual oil (to generate electricity), the use of gasoline and diesel fuel (for trucks and tractors to transport raw materials and finished products), and finally the combustion of natural gas (for heating and hot water supply).

The leading American analyst Jim Puplava claims that producing industrial alcohol from corn is completely inefficient under current conditions: “If we calculate the expense of the natural gas consumed in producing fertilizers, the amounts of fuels and lubricants required to treat crops and gather the harvest, and consider that automobile gas mileage per unit of fuel is reduced by approximately a quarter after switching from gasoline to ethanol, the resulting energy balance is negative.”¹⁶

Neither should the adverse environmental impact be disregarded. According to the authoritative journal Science, producing bioethanol releases 179–212 pounds of CO₂ per megajoule into the atmosphere, that is, almost as much as when gasoline is burned (207 pounds of CO₂), which is not at all surprising given the EROEI of bioethanol. Producing bioethanol from vegetable materials also involves the use of sulfuric acid, and so far no one has found a use for the sulfonated lignin byproduct.

To expand their so-called “energy-intensive” plants, American farmers who sell their cereal crops for biofuel production must chop down forests, which decreases biodiversity, impoverishes ecosystems, and results in deforestation, salinization, and subsequent soil erosion.

Other countries attempting to follow the route of accelerated biofuel production have encountered problems similar to those in the US. Along these lines, one widely publicized project that Japan never succeeded in realizing is rather revealing. In the summer of 2008, on the eve of the G8 summit in the vicinity of Lake Toya on Hokkaido, the Japanese government decided to demonstrate to the world its desire to develop alternative forms of fuel in the war on global warming. It was expected that the small island of Miyakojima would become a prototype of the “Japan of the future,” where gasoline containing ethanol would be sold. There are 19 filling stations on Miyakojima, and the 35,000 automobiles owned by local inhabitants annually consume 27,550 tons of gasoline. At the same time, the island produces a lot of sugar, and the raw material for its production is very well-suited for producing ethanol. However, preliminary calculations by specialists at major Japanese oil companies, including Nippon Oil Corp., showed that this project would not bring anything but serious losses, and in so doing could seriously damage the reputation of national industry. Thus, the idea of turning the island into a zone completely free of conventional gasoline remained an impossible dream.

At present, biofuel accounts for around 1.5% of total worldwide vehicle fuel consumption. In the foreseeable future, it cannot replace natural oil as a raw material for producing fuel. In its report World Energy Outlook 2006, the International Energy Agency emphasized that, even if a full-scale active policy were pursued with very significant investments, biofuel’s share could not possibly grow to more than 8–12% by 2030.

Incidentally, in the words of Abdalla Salem el-Badri, secretary general of the Organization of Petroleum Exporting Countries (OPEC), the all-out passion for biofuel could make it harder for cartel members to keep oil production at the former level. OPEC members think that it could seriously reduce investments in oil production, and consequently lead to a new spiral of increases in fuel prices.

Another point of discussion in the Russian and foreign press is what place Russia will occupy in the process of developing alternative sources of energy, since—as is the case with oil and natural gas—it has the lion’s share of world reserves of alternative energy potential. And although Russia has large reserves of raw hydrocarbons, it also needs diversified energy sources, including the use of renewable energy resources. Several experts have estimated that Russia’s potential reserves of alternative energy sources are around 5.1 billion TCE per year, which is five times the country’s consumption of all conventional energy resources. However, the economic potential for their use is negligible so far. The Russian government understands this problem, and soon plans to adopt a federal targeted program to develop renewable energy sources in Russia.

Looking back at history, on October 8, 1975, at a scientific session commemorating the 250th anniversary of the USSR Academy of Sciences, the eminent scientist Academician Pëtr Kapitsa (1894–1984), Nobel laureate in physics, gave a conceptual talk about the future of alternative energy. Proceeding from basic principles of physics, he made logical assessments of wind power, geothermal power, wave power, and hydropower, and proved that using existing technical and technological approaches, all these sources would be unable to provide any serious competition to fossil fuel in the last quarter of the 20th century.

On the whole, it can be firmly stated that the Russian academician’s prediction is still valid today. Despite the efforts of the world community to increase the share of alternative forms of energy consumed, conventional energy sources will continue to dominate in the near future. According to estimates given in presentations by leading specialists at the International Alternative Energy Forum held in mid-February 2009 in Verona, Italy, fossil fuels—oil, natural gas, and coal—will continue to account for at least 80% of global energy consumption through 2030. And here the leading world experts were unanimous in their opinions: it will only be possible to speak seriously about developing alternative energy after the costs of producing alternative energy become equal to the corresponding costs associated with conventional sources—that is, no earlier than by the middle of this century.