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The Wall Street Journal: Russia Rushes East in Search of Oil

Siberian Crude Offers
New Source of Output;
Costly, Tough Projects
By GREG WALTERS
May 16, 2007

VANKOR, Russia — Russia is scrambling to unlock the vast oil wealth of East Siberia to keep crude output in the world’s largest oil producer from falling. To succeed, Russian companies will need deep pockets.

High oil prices have helped Russian oil companies post record profits in recent years. But as output growth from Russia’s main oilfields in western Siberia begins to slow, the country’s oil giants are pushing eastward to tap new resources under some of the world’s most forbidding terrain.

“It’s difficult to overestimate the importance of East Siberia for our company, for the future of Russian oil,” says Mikhail Stavsky, vice president for production at Russia’s biggest oil producer, state-controlled OAO Rosneft. “But when you fly over this region, you see that the geography is much more difficult than where we work today. Clearly, this is going to require a lot of money.”

Almost as large as the continental U.S., East Siberia has few roads or power lines. Temperatures can plummet to minus 60 degrees Celsius. A proposed oil pipeline linking the region to East Asian markets will be longer than the distance from New York to Los Angeles, and the cost of the project is spiraling.

“We’re working under the assumption that it’s going to be two or three times more expensive to develop fields in East Siberia than in West Siberia,” says Matt Thomas, an analyst at Morgan Stanley.

Without new production in regions like East Siberia, crude oil output in Russia, the world’s second-biggest oil exporter after Saudi Arabia, will flatten or decline, industry observers say. Although Russia is the world’s largest crude producer, at 9.79 million barrels a day, much of its production goes to domestic use rather than for exports.

Oil output growth in Russia has slowed in recent years from double-digit expansion as recently as 2003 to just 2% last year. During the boom years, growth came from reinvigorating oil regions first developed in the Soviet era, primarily in western Siberia. In the future, growth will come from new projects in places such as Russia’s untamed east, with much higher start-up costs.

East Siberia lies to the north of Mongolia in the heart of Russia’s enormous, 11-time-zone land mass. The region is bordered by Russia’s Pacific coastal area, known as the Far East, beyond which sits oil-rich Sakhalin Island to the north of Japan, where Royal Dutch Shell PLC and Exxon Mobil Corp. have large operations.

Total capital spending in East Siberia will be about $20 billion to $25 billion just through 2010, according to an estimate by Moscow’s Alfa Bank, up from about $2 billion in 2006.

Exactly how much oil can be pumped from the frozen East Siberian ground remains uncertain, but some estimates say the volumes could be enormous.

East Siberia’s proven crude reserves amount to about seven billion barrels, according to a recent estimate by Anglo-Russian oil company TNK-BP Holdings, 50%-owned by BP PLC. But less than 5% of the region’s oil-producing zones have been explored, so the potential reserves are likely to be much larger. TNK-BP predicts the region’s crude reserves could reach 75 billion barrels, or as much as the proven reserves for the entire country. Russia’s Ministry of Natural Resources estimates the region may hold as much as 110 billion barrels, although the ministry itself classifies that figure as speculative.

Russian officials are pushing companies to look harder. Russian Minister of Natural Resources Yuri Trutnev is calling for a dramatic increase in exploratory work in East Siberia, saying that if more reserves aren’t booked, the region’s output may peak at a mere 25 million metric tons a year, or 500,000 barrels of oil a day. Only marginal amounts of crude are being produced in the region now, and current rates of exploration “will hardly ensure quick oil reserves replacement,” Mr. Trutnev says.

Some observers argue that the development of East Siberia will require foreign capital, although Russia has made it more difficult for foreign players to gain access to significant reserves in recent years.

“There is at least a question mark over whether state companies have the funds and the expertise” to develop the area, says Roland Nash, head of equity research at Renaissance Capital.

Others, however, note that Russian firms have good relations with Western oil-field services firms such as Halliburton Co. and Schlumberger Ltd. and can call on their expertise without ceding control of the fields.

Minister Trutnev recently brushed aside calls to bring foreign oil companies into East Siberia. “We respect foreign investors, but we respect Russian ones more,” Mr. Trutnev said. “This is a question of strategic resources.”

Vankor, Rosneft’s flagship project, is a case in point. French oil company Total SA once held an option for 52% of Vankor but lost it after Rosneft in 2002 bought the company that had sold Total the option and said it was no longer interested in cooperating with Total on the field. Total went to an international arbitration court in Brussels but lost.

A trip to Vankor, the biggest new oil development in East Siberia, targeting 400,000 barrels a day by 2012, demonstrates the challenges. Vankor, more than 100 kilometers north of the Arctic circle, is accessible by car only when the roads are frozen. In the summer, workers use helicopters. Work stops only when temperatures plunge below minus 43 Celsius, and the snowbanks don’t melt until June. Significant commercial production is to begin in 2008.

The Verkhnechonsk field, majority owned by TNK-BP, aims for 200,000 barrels a day. The smaller Talakan field, being developed by Surgutneftegaz, is expected to peak at 140,000 barrels a day.

Still, Russian state officials question the companies’ ability to pump enough crude there to justify a planned 1.6 million-barrel-a-day pipeline to East Asian markets.

A first stage, from Taishet in East Siberia to Skovorodino near the Russian-Chinese border, is scheduled for completion by late 2008, with a capacity of 600,000 barrels a day. The price tag of this first stage has ballooned from $6.6 billion to more than $11 billion.

Officials now say this first stage will initially need significant amounts of West Siberian crude, and that construction of the second stage, from Skovorodino to Russia’s Pacific Coast, won’t begin until at least 2014.

Write to Greg Walters at [email protected]

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