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Russian oil drop may be inflating prices

The Sunday Business Post: Russian oil drop may be inflating prices

20 April 2008 By Philip Andrews in Moscow

The International Energy Agency has hinted that a 1 per cent drop in Russian output in the first quarter of 2008 is contributing to record oil prices. This is the first time in ten years that Russian production will have fallen.

Analysts say the fall may be anomalous, due simply to high taxes and inadequate reinvestment. Russia is the world’s second-biggest producer of crude oil and one of its main exporters, with reserves of about 40 billion tons, of which 25 billion are on its continental shelf.

World output is about 11 million tons per day; the New York exchange (NYMEX) alone is trading around 30 million tons (220 million barrels) of oil daily. But the director of the St Petersburg Mining Institute, Vladimir Litvinenko, sent shivers down Russian spines when he suggested contemporary Russian oil fields would continue to produce for only another ten to 20 years.

The high price of oil, although good news for the Russian government, is not good news for Russian oil companies. Higher prices paid for Russian oil during the preceding month lead to higher taxes and, in particular, to higher export duty on oil for Russian producers. A falling price only affects the export duty rate many weeks later.

This situation – in which companies like Lukoil, Surgutneftegaz, Rosneft, Tatneft, Gazpromneft and TNK-BP find themselves – handicaps the companies’ ability to use potential profits for improvements and further exploration.

In many cases, Russian oil producers cannot take advantage of world demand. The first major difficulty is the outdated transport system. The grid stretching across Eurasia largely dates back to the Soviet period.

Older sections of the pipelines, run by state-owned Transneft, are in serious need of replacement. They cannot handle extra pressure, so there is a reduction in volume and speed. Surgutneftegaz’s deputy director, Vyacheslav Nikiforov, has predicted that Surgut’s production could fall by nearly four per cent this year, due to delays in opening a new pipeline to China.

Higher taxes are also slowing down production, as companies are squeezed to the point of not reinvesting profits in new equipment and modernisation.

Many oilfields were originally drilled in the Soviet era and are now beginning to dry up. Ninety per cent of oil resources discovered over the last century have been fully exploited. Insufficient new wells are being drilled, due to investment and environmental risks, and infrastructure and climatic concerns.

Foreign oil companies like Shell and BP are reluctant to invest further in exploration and production in Russia after a serious of setbacks over the last few years.

Shell was ‘encouraged’ to reduce its stake in Sakhalin Energy in favour of Gazprom after the environment ministry accused Shell of abusing the rights of indigenous peoples and causing environmental harm by drilling for gas in the Sea of Okhotsk off Sakhalin Island in the Russian far east. The damage was valued at more than $20 billion two years ago.

The inability of Russian oil companies to keep up with global demands is also due to the harsh Russian climate and the remote locations of oilfields. Much of Russia’s oil is drilled around the Ural Mountains.

The accessible and more temperate regions around cities like Samara, Ufa and Kazan in European Russia account for only a small percentage of the ten million barrels produced daily.

The harsh climate, northern tundra, western Siberian marshes and lack of rail and road infrastructure make it exceptionally difficult to transport equipment and construct support structures.

Arctic temperatures, dark winters and summer swarms of mosquitoes greatly handicap operations. Building new roads and laying rail lines is out of the question, while the building of pipelines is hugely expensive because of the vast distances involved. All are contributing to the drop in production and consequent rise in oil prices.

http://www.sbpost.ie/post/pages/p/story.aspx-qqqt=WORLD-qqqs=news-qqqid=32186-qqqx=1.asp

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