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Russian bear is in trouble

Russian bear is in  trouble
I am currently working and living in Sarajevo, the capital of Bosnia and Herzegovina. I had no gas in my apartment for four days when Gazprom/Russian Federation stopped supplies to Ukraine.

I am currently working and living in Sarajevo, the capital of Bosnia and Herzegovina. I had no gas in my apartment for four days when Gazprom/Russian Federation stopped supplies to Ukraine.

Sarajevo and the rest of the country is 100% dependent on gas from Gazprom, which is piped via Ukraine and Serbia.

It was a bitterly cold and snowy period. My apartment, like many others in that city, is entirely dependent on gas for heating, so we had a miserable few days. I am too old to enjoy cold showers.

I did not understand Gazprom’s tactics or, probably more accurately, those of Vladimir Putin, the current prime minister of the Russian Federation, who seems to have been pulling the strings.

The main objective of the gas dispute appears to have been to undermine the Ukrainian presidency. But, in doing so, Gazprom and the Russian Federation lost a lot of credibility in their main energy export markets in Europe.

I find it difficult to understand why they did that because the Russian oil&gas industry is in a surprisingly weak position and needs to maintain good relationships with key customers in the European Union and elsewhere.

When oil&gas prices were high, Putin clearly believed his country was in a very strong position and encouraged some very aggressive actions. Examples of those are the legal actions against the BP-TNK joint venture and Shell’s Sakhalin Island project, as well as the recent one of Gazprom.

The collapses in world oil&gas prices have not only substantially reduced the incomes of the Russian petroleum companies, as well as the federation government’s tax revenues, but also revealed some serious weaknesses in the Russian upstream sector that are likely to restrict it for many years.

Economists sometimes describe the revenues from unusually high oil&gas prices as windfall profits. To their credit, many companies, notably Saudi Aramco, other national oil companies and a few of the multinationals, have reinvested many of these windfall profits in the industry.

But not the oil&gas companies in the Russian Federation.

It is not easy to find out what the likes of Gazprom, Rosneft and Sibneft have done with their exceptionally high earnings over the last two years, but there is little evidence of sensible investment.

The Russian Federation has some of the world’s largest known oil&gas reserves, but production is now declining – not because of Opec-style policies, but because of a long history of under-investment in both existing fields and new discoveries. It was the second largest producer and exporter of oil in the world last year after Saudi Arabia. Output has increased by more than 50% over the past decade, to about 10million barrels per day (bpd).

However, I expect output to fall by up to 500,000bpd during 2009 because of the lack of investment in domestic fields over the last few years. The ongoing financial crisis has also weakened the investment capabilities of the main companies.

The reserves:production ratio is only about 22, compared with the world average of 42 and 70 in Saudi Arabia. That implies that the country can produce oil at the current level for only another 22 years.

The Russian Federation was the largest producer and exporter of gas in the world last year but, overall, output has fallen in the last two years. The gas reserves:production ration is estimated at about 75, but that potential requires massive investment to turn it into actual output.

Most of the investment in new fields in recent years has been made by foreign companies such as BP, ExxonMobil and Shell. This makes the ongoing harassment of such companies very difficult to understand because it will inevitably result in even lower investment and the possible withdrawal of some of the multinationals.

The domestic companies also need the technical expertise of foreign players, particularly in difficult hydrocarbon provinces such as Sakhalin and the Barents Sea.

It seems to me that the main Russian petroleum companies have neglected their domestic reserves in favour of overseas expansion. A recent example of that is Lukoil’s bid for a 30% stake in Repsol YPF of Spain. Gazprom has also been acquiring interests in Venezuela and Brazil, as well as in Eastern Europe.

These policies of overseas expansion and domestic neglect are now rebounding on the country. For example, China has just agreed to lend $25billion – $15billion to Rosneft and $10billion to Transneft – to enable them to develop oilfields in Eastern Siberia which will supply China with 300,000bpd over the next 20 years (see news story on Page ???).

Similarly, Gazprom is not now in a position to finance proposed new gas pipelines such as Nord Stream and South Stream, and will be dependent on foreign investment. Given the recent gas crisis, I think that very unlikely, at least over the next few years.

It is going to be a very challenging period for the Russian oil&gas industry. Mr Putin and his political colleagues will have to interfere less if the industry is to come out of it stronger than now.

Tony Mackay is the MD of economists Mackay Consultants

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