RUSSIA - Part 2 - The Oil & Gas Producers.

More than 12 vertically integrated majors account for almost 90% of the Russian Federation's crude oil and condensate production, with total output exceeding 9.6m b/d, up from 7.698m b/d in 2002, 6.5m b/d in 2000 and a low of 5.85m b/d in 1998. These companies have been privatised. Gazprom, the biggest company in Russia, produces most of the federation's natural gas needs and exports.

Russia has proven oil reserves of 69.1 bn barrels mostly located in west Siberia, between the Ural mountains and the central Siberian plateau. In the 1980s this "Russian Core" made the Soviet Union the world's biggest oil producer, allowing for peak output of 12.5m b/d in 1988 mostly from Russia. After the collapse of the Soviet Union in late 1991, oil production fell precipitously, reaching 5.85m b/d in 1998. Factors causing the decline included depletion of the largest fields due to state-mandated production surges and the collapse of central planning.

According to a plan announced in late January 2006, Russia will produce 490-500m tons of crude oil and condensate by 2008, against 470.2m tons in 2005 and 459m tons in 2004. The stated rise in output will be achieved through re-exploration of existing fields and developing new fields in the Tomsk and Krasnoyarsk areas. To develop the transport infrastructure, it is planned to rise capacity of the Baltic pipeline to 60m tons/year in 2006. The first stage to construct the East Siberia-Pacific Ocean pipeline will be initiated in 2008 (see Part 3).

Russian oil/condensate output slipped in July to 9.68m b/d after hitting a new post-Soviet high of 9.69m b/d in June. Energy Ministry data on Aug. 1 showed crude oil exports through the state's pipeline monopoly Transneft edged down to 4.56m b/d from 4.68m b/d in June. Russian oil production, the world's largest with Saudi Arabia producing 9.3m b/d, has fully recovered in the past months from a deep winter slump when it fell to as low as 9.43m b/d. July production was 2.4% higher than July 2005. Year to date production stood at 9.57m b/d, up 2.35% from 9.35m b/d in January-June 2005. The modest percentage growth figures were in line with forecasts from the government and analysts. Investment bank Deutsche UFG in early August said: "We reiterate our full-year growth forecast of 2% on the back of expected problems at Yukos and GazpromNeft".

Yukos, once Russia's largest oil producer (see its 2004 profile in Vol. 63, OMT & DT No. 8), was declared bankrupt on Aug. 1. It says its downfall is the result of a Kremlin campaign to grab assets and destroy its politically ambitious owners. Yukos's production fell sharply as well as output at GazpromNeft following the purchase of Sibneft by the state-controlled gas monopoly Gazprom. Analysts are bullish on output growth prospects, including Renaissance Capital, which sees annual growth at 3.6%. "Matters will be helped by a big ramp-up of production from Sakhalin-1, once exports can begin from the De Kastri terminal from October", says Adam Landes from RenCap, adding: "We also anticipate that the year-on-year growth rate could surpass 7% briefly in the first quarter of 2007, and that this will continue to surprise oil markets".

Russian oil/condensate output growth had slowed to 2.7% in 2005 from 9% in 2004 and a record 11% in 2004. The slowdown came as state-controlled GazpromNeft and Rosneft, which are less efficient than private producers, regained a big part of the Russian oil industry through the demise of Yukos.

Russian oil reserves are becoming depleted and the country needs to tap major new deposits in new areas such as East Siberia to support growth. In March 2005, Gennady Small who heads Russia's Oil & Gas Industry Union, said 23.8% of Russia's oil wells had been exhausted. He put the depletion rates as follows: 56% at Sibneft (now part of Gazprom), 38.7% at TNK-BP, 30% at Yukos, 19% at LUKoil which now is Russia's biggest oil producer, and 12% at SurgusNefteGaz.

Small warned that, if Russia failed to develop new deposits and did not enact a new law to stimulate oil production, it would have to stop exporting as it would hardly be able to meet domestic demand. He said in the next ten to 15 years, western Siberia would continue to be the main oil producing area. But later this will shift to eastern Siberia, a region which will enable Russia to export to the Far East and achieve new geo-political objectives in that part of the world.

Production of natural gas increased 1.13% in 2005, to 640.634 BCM. In the fourth quarter, Russia produced 171.336 BCM of gas, including 59.107 BCM in December. Gazprom reported an output of 547.249 BCM in 2005, an increase of 0.82% compared with the previous 12 months. In the fourth quarter of 2005, Gazprom produced 146.524 BCM of gas, including 50.327 BCM in December.

The oil production system has been improved by the private and integrated Russian companies, which have amassed a lot of cash since 1999, and joint ventures involving foreign firms. The Russian oil firms are ranged in two categories: the aggressive groups which have raised output quickly and cut costs with the help of Western service firms, as in the case of TNK-BP and Sibneft (now part of Gazprom); and conservative groups like LUKoil.

There are three types of oil operators in Russia: the integrated firms, include-ing TNK-BP, of which the top three together produce over 5m b/d; private and independent Russian firms which produce a total of less than 350,000 b/d; and JVs between Russian and foreign companies, which produce about 580,000 b/d. There are two categories of JVs: those operated by foreign firms, like Polar Lights involving ConocoPhillips, and those operated by Russian companies like LUKoil-AIK.

The integrated companies own most of Russia's oil refineries. Firms in relatively more autonomous member-republics include TatNeft of Tatarstan and BashNeft of Bashkortostan. There are also independent Russian oil refining and distribution companies (see profiles in Downstream Trends).

West Siberia remains the main oil producing part of Russia, accounting for two-thirds of the country's total output. This is where oil in place is still about 150 bn barrels, nearly three times what has already been produced. But the companies are shifting to new frontiers in the north, east Siberia and the Far East and back to the industry's roots in the Caspian.

Two major mergers were announced in 2003: Tyumen Oil Co. (TNK) with British Petroleum (BP) in February 2003, and Yukos with Sibneft in April 2003. By early 2003, the Russian oil industry was dominated by five companies: Yukos, LUKoil, Surgutneftegaz, TNK, and Sibneft. Combined, these companies accounted for about 70% of the country's oil output in that year. The other 30% belonged to about 150 small-to-medium sized oil producers. While one merger - TNK-BP - was completed as a 50-50 JV, YukosSibneft fell apart towards the end of 2003 with the owners of Yukos now in jail or in exile and the company being bankrupt. In October 2005, Gazprom bought Sibneft.

Fiscal claims by the Moscow government, which are common in Russia due to frequent changes in legislation, are one of the key risks facing businesses, and are frequently condemned by business people as a means of exerting pressure on them. A Moscow arbitration court has recently confirmed a US$130m back-tax claim for fiscal 2001 against TNK-BP, Russia's second-largest crude oil producer and third exporter. The firm had disputed the claim before the court ruling on Aug. 11. Analysts at Deutsche UFG were on Aug. 15 quoted as saying the claim was a modest one for TNK-BP, but "lessens its chances of reducing another back-tax claim of about 2.1 billion dollars". TNK-BP has set aside US$1.5 billion in view of numerous tax claims against it (see TNK-BP profile in Downstream Trends).

International rating agency Fitch on Aug. 14 said Russia's move to cut crude oil supplies to a major Lithuanian refinery could be political. After an accident on the Druzhba pipeline in western Russia in July, crude oil supplies to the refinery, Mazeikiu Nafta (MN), were interrupted and have not been fully resumed. Fitch said: "If supplies of Russian crude oil by pipeline to MN are not resumed within the next few weeks, this could lead one to conclude that political rather than technical reasons are to blame for the supply disruption, as the Lithuanian refinery was recently acquired by Polish PKN and not by a Russian oil company".

Bankrupt Yukos had previously held a controlling stake in the Baltic region's largest refinery, which the Lithuanian government recently bought, before selling to the Polish company, rejecting bids from leading Russian oil producers. The agency also said that oil refineries in Central Europe were vulnerable to supply risks due to their dependence on Russian crude oil (see Part 3). Fitch said: "While recent supply problems due to a leak in the northern branch of the Druzhba pipeline were only experienced by Lithuanian refinery Mazeikiu Nafta AB...most other refineries in the CE region are dependent on pipeline supply from Russia".

Refineries in the region do have access to alternative supplies of crude oil, but interruptions to supplies from Russia would severely hit their profits, Fitch said, adding: "CE refineries' dependence on Russian crude is a combination of historical reasons and refinery location on the pipeline from Russia. This is also driven by increasing price advantage of Russian crude oil, which is sold at a discount to Brent...(as much as US$5/b in Q206). It is Fitch's view that a mixture of political and economic reasons are behind the interruptions of Russian crude oil and gas supply to Central Europe experienced in the past two years... However, Fitch views that intentional long-term supply disruption to CE refineries is unlikely given that Russian oil companies remain interested in exporting crude oil to this region, given its price advantage over domestic sales and difficulties to redirect such significant amounts of crude oil into other export routes".