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Russian Oil Slump Stirs Supply Jitters

Wall Street Journal

THE WALL STREET JOURNAL: Russian Oil Slump Stirs Supply Jitters

Production Decline
Is First in 10 Years;
Squeeze in Siberia
April 15, 2008

Russian oil production, for years a vital source of new supplies for world markets, is showing signs of a slump, adding to uncertainties that have helped push oil prices to record highs.
Russian output fell for the first time in a decade in the first three months of this year, according to the International Energy Agency, which represents industrialized oil-consuming countries. It said Russian production averaged about 10 million barrels a day, a 1% drop from the first-quarter of 2007.

Declining production from the world’s largest oil producer and one of its largest exporters puts further pressures on an already strained market and adds to the potential for higher prices for a global economy coping with a slowdown. Global production constraints — along with surging demand, rising oil-field expenses and political instability in petroleum-rich regions — already have sent oil to more than $110 a barrel from $30 in about four years.

In New York futures markets Monday, oil reached another new high on the falling dollar and other supply constraints. It settled at $111.76 a barrel, up $1.62, or 1.5%.

Industry watchers and Russian officials generally blame the country’s production slowdown on a combination of weather and tight electricity supplies in some parts of the country. In a longer-term worry, they also point to aging Siberian fields that once fueled its production growth.

Many Russian oil officials say the industry could still resume growth. Some Western analysts point to more optimistic data and forecasts. Citigroup said in a report late last month that it expects Russian oil volumes to increase by 1.5 million barrels a day between now and 2012, largely thanks to new projects in eastern Siberia.

Still, it cautioned: “Russian oil production growth is no longer to be taken for granted.”

The IEA predicts Russian oil production will resume growth this year. But it estimates an annual increase of only 0.8% over 2007, compared with an average 2.5% in the past three years and much faster growth before that.

Russia’s energy ministry expects a rise of 1.8%. But earlier this month, Yuri Trutnev, the nation’s natural-resources minister, said on Russian television that the country’s full-year production may be lower than last year’s.

Russia’s stumbling production growth highlights a troubling reality: Despite soaring oil prices in the past five years, crude output from nations outside the Organization for Petroleum Exporting Countries has remained essentially flat since 2005, defying the normal link between high prices and increased production.
The tightness has increased the pressure to find new supplies outside OPEC. Shares of Brazil’s Petroleo Brasileiro SA, known as Petrobras, surged Monday after it reported a potential big new find off that country’s coast.

Exploration Costs

The reasons for the non-OPEC plateau range from spiraling exploration costs to the increasingly remote climates where new oil pockets are being found. Also, many major sources are aging. Europe’s North Sea, Alaska’s Prudhoe Bay and Mexico’s Cantarell field in the Gulf of Mexico have all seen declining output.

The economic downturn in the U.S., by far the world’s largest oil consumer, has taken some steam out of oil demand. But fast-growing Asia and other places are still adding to demand, and many analysts worry that a global supply pinch later this year could send prices higher.

“There isn’t a lot of supply coming on right now, so this [lack of non-OPEC growth] is framing the whole narrative of the market,” said Roger Diwan, a financial energy adviser at consulting firm PFC Energy in Washington.

OPEC supplies more than a third of the world’s petroleum needs, which reached about 87 million barrels of oil a day in the first quarter, according to the IEA.

Russia’s rising affluence, leading to greater domestic consumption, is also reducing the amount it can export to the rest of the world. Driven by Russia, demand from the former Soviet Union is expected to rise 1.6% this year to 4.2 million barrels a day.

In an interview, Leonid Fedun, vice president of OAO Lukoil, one of Russia’s biggest oil companies, said a mild winter and higher temperatures mean Siberia’s icy ground is less stable, making it harder to move drilling rigs between oil wells.

He acknowledged that the fall also reflects a longer-term trend — the depletion of Siberia’s older fields. “Western Siberia is repeating the fate of Prudhoe Bay, with a time lag of five to six years,” he said. “When the well’s productivity falls, you have to keep drilling more and more. You’ve seen it in Alaska and the Gulf of Mexico, and now you’re seeing it in Siberia.”

Russian oil output collapsed after the breakup of the former Soviet Union when the price of crude plummeted and investment dried up. But it began to recover in 1999 as newly minted private oil companies used Western techniques to rejuvenate mature fields. Russia became a major source of new barrels. Its petroleum output grew from six million barrels a day in 1996 to an average of about 10 million barrels last year, according to the IEA. Saudi Arabia during the same period went from around 7.9 million barrels a day to 8.5 million barrels last year.

Business investors have grown wary because the Kremlin has increasingly intervened in the energy sector. Russia nationalized former oil giant OAO Yukos and forced foreign investors like Royal Dutch Shell PLC to sell half its stake in a big project off Russia’s east coast to the state-run OAO Gazprom. TNK-BP has also come under pressure: Last month, intelligence services arrested one of its employees on suspicion of industrial espionage. TNK-BP said it is cooperating with authorities.

In an effort to kick-start investment, Russia’s government recently unveiled a $4.2 billion tax cut for the sector. It was broadly welcomed in the industry. “It’s a very important point that the Russian government has realized that with cost growth and inflation, there needs to be additional relief for companies to develop fields,” said Bob Dudley, chief executive of TNK-BP, BP PLC’s Russian joint venture.

It may not be enough. Lukoil’s Mr. Fedun says Russia’s oil industry needs $1 trillion of investment during the next 20 years just to maintain production of 10 million barrels a day. Analysts worry the tax cut is inadequate to achieve that. “We still do not see it generating enough free cash flow to the industry…to support higher investment levels,” Citigroup said in its report.

Russian oil officials and the world’s oil companies say the country needs to open up the remote, untapped expanses of East Siberia to ensure future growth. But the lack of infrastructure such as roads and pipelines and the harsh operating conditions limit growth. Oil companies also have been deterred by heavy taxes that provide little incentive to invest in new production.

Oil companies are dealing with the depletion of reserves in western Siberia by diversifying. Lukoil, for example, is focusing on new areas like the North Caspian Sea, and expanding abroad in places like Turkmenistan.

Falling Short

New developments so far are failing to offset the decline. Sakhalin 1, a huge project off Russia’s east coast led by Exxon Mobil Corp., accounted for much of Russia’s production growth in 2007. But output there will drop by more than 25% this year, according to OAO Rosneft, the state-run oil giant that is a partner in the project. In a statement, Exxon said it “has met and continues to meet or exceed the project production targets approved by the Russian authorities.”

Most forecasts predict that liquid-fuel demand world-wide will hit 100 million barrels a day by 2015. To meet that, producers will first have to make up for steep declines in existing fields. That decline rate now subtracts an estimated 4.5 million barrels a day from annual output.

Former big producers like the U.K., Norway and Mexico are also fighting to squeeze oil from once mighty but now increasingly old and tired fields. In Canada, where output is increasing thanks to massive investments in Alberta’s oil sands, production costs now top $65 a barrel by some estimates. Mexico last week pushed a plan to allow its state oil company to enter into service agreements with foreign oil companies, but observers said it may not be enough to attract big investment.

There are bright spots on the production front. Analysts point to big projects in the Caspian as well as deep-water projects off Australia, Brazil and in the Gulf of Mexico, including BP’s long-delayed Thunder Horse platform.

–Spencer Swartz and Gregory L. White contributed to this article.

Write to Guy Chazan at [email protected] and Neil King Jr. at [email protected] and its also non-profit sister websites,,,,, and are all owned by John Donovan. There is also a Wikipedia article.

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