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Monday, March 13, 2006

OPR WEEKLY: STATE RESURGENT: THE RENATIONALIZATION OF RUSSIAN OIL

While the forced renationalization in December 2004 of Yukos’ Yuganskneftegaz was the loudest (and messiest) of the Kremlin’s push to gain control of Russia’s oil industry, it seems to be part of a still ongoing trend. It will be instructive to review the bidding on just where the renationalization plan stands, and where it may go next.

Following the collapse of the Soviet Union, enterprising and opportunistic oligarchs moved quickly to secure control of Russia’s major oil producers, combining them with the refining assets that had served the companies during the communist era. A cadre of powerful conglomerates took control of the country’s oil exploration and production, including Yukos, Lukoil, Sibneft, Slavneft, Tynumen Oil Company (TNK), Slavneft, Surgutneftegaz, Tatneft, and Bashneft. Only Rosneft remained in the state’s portfolio.

The country’s dominant gas producer, Gazprom, and its pipeline monopoly, Transneft, also remained in state hands. However, it is not surprising that these latter two entities remained in Kremlin control. Two-third’s of Russia’s enormous gas production is used for domestic consumption. In order to manage important subsidies of natural gas to Russian customers during the tumultuous decade after the collapse of the Soviet state, it made good sense for Gazprom to remain an arm of the state. Similarly, given the importance of Russia’s pipeline system for oil and gas exports -and the importance of oil and gas exports to the Russian economy- it made sense to keep Transneft in state control as well.

When the Kremlin moved in late 2003 to dismember Yukos, the consensus view was that it was for political, not economic, reasons. Yukos founder and CEO Mikhail Khodorkovsky had made little secret of his political pretensions and Russian President Vladmir Putin acted swiftly and brutally to quash his would-be rival by levying over $30 billion in back taxes. Khodorkovsky now languishes in a Siberian prison camp, while Yukos’ major production asset, Yuganskneftegaz, auctioned off at price well below its market value, is now owned by state oil firm Rosneft.

Yukos’ remaining production assets have been struggling to cover the rest of the tax burden, and until last week it seemed that the trimmed down company might survive. With its politically dangerous founder in prison, the company appeared to be of little threat to Putin. Last week’s events, however, make clear that the Kremlin won’t rest until the company is fully dismantled. If bankruptcy proceedings against the company commence, it is likely that even more of its assets will end up in state control.

The Kremlin, however, has also moved –albeit more civilly- to control other important oil assets. While the government’s plan at the outset seemed to be to incorporate Yuganskneftegaz into Gazprom, thereby giving the gas behemoth significant pull in the oil industry, the move failed for a variety of political and legal reasons. However, in October 2005 Gazprom purchased Sibneft, Russia’s fifth largest oil producer. Combined with Gazprom’s original oil assets, the purchase turned the gas company into a significant petroleum producer. Between Rosneft (including Yuganskneftegaz) and Gazprom (including Sibneft), the Russian state controls the country’s second and fifth largest oil companies, as well as the 50 percent of Slavneft owned by Sibneft.

Russian Oil Production in January and February 2006 (million tons)

Lukoil

14.318

Rosneft*

12.336

TNK

11.845

Surgutneftegas

10.455

Sibneft*

5.063

Tatneft

4.131

Slavneft

3.869

Yukos

3.458

Gazprom*

2.184

*State owned company

The state, however, may not be stopping there. Rumors have surfaced recently that Rosneft may be eyeing a purchase of Surgutneftegaz, Russia’s fourth largest oil conglomerate. The company has long had close ties with the Kremlin and would integrate relatively easily into state run Rosneft. While Rosneft is cash-strapped following its purchase of Yuganskneftegaz, it is planning later this year to go public in Russia’s largest ever IPO. The offering is expected to garner as much as $17 billion for the company. What better to do with cash on hand than purchase another oil major. The a Rosneft-Surgutneftegaz combination would put the company far ahead of Russia’s current leading producer, Lukoil.

In addition, the Kremlin is also rumored to be interested in taking control of Slavneft and the half of TNK-BP held by Alfa and Access/Renova. While no concrete plans for takeover have surfaced, the prospect is clearly worrying to those who fear increased state dominance over the oil industry. If both of these moves come to pass, the state share of Russian production would be truly immense.

What effect these moves would have on Russian production is unclear, primarily because the future character and stability of the Russian state is unclear. The prospect of Russia wielding its oil power similarly to its wielding of its natural gas power is undoubtedly unsettling to Russia’s primarily European customers. On the other hand, future Russian production may depend on development of risky and expensive projects in East Siberia and the Arctic shelf. To the extent that the state is capable of longer time horizon’s and greater capital commitment to such projects, Russian dominance may turn out to be beneficial in the long run.

Regardless, the coming year will tell us a lot about the future of Russia’s oil industry and thus about the Russian state.

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