High oil prices: Which tactic will Russia choose?

Vasily Zubkov, Economics Analyst, RIA Novosti, Moscow

World oil prices are going through the roof. The majority of serious experts have already been proven wrong in their predictions for 2004. But what steps will Russia take in the current oil-trading situation? There are three probable scenarios.

Scenario one: Russia considerably increases exports. OPEC is expected to approve an increase in production at an official session in Beirut on June 3. Russia is expected to follow suit.

Russian Finance Minister Alexei Kudrin is certain that the country's leadership will maintain its export policy and pursue its strategy of increasing the offer. Although, in his opinion, the current trend on the world oil markets might not be a long- term one, it will still benefit the country. "Russia should raise production and sell more oil at higher prices," he says.

One person who shares this viewpoint is Prof. Yevgeny Yasin, a one-time minister of economic development. He believes that "oil- dependency" is good for the Russian economy and that the favorable situation on the markets should be exploited to reform industry. "God gave Russia these huge resources, so it is not worth wasting their competitive advantage," he recently told journalists.

Oil extraction in Russia has gone up significantly this year. In the first four months of 2004, extraction hit 147.2 million tons, which is 14.2 million more than for the same period last year. The current levels were only predicted for the 2008-2010 period.

Russia's oil barons are in favor of developing production, even though the influence in the Kremlin has waned considerably.

Scenario two: Russia gradually scales back the extraction and sale of oil abroad, compensating for possible losses with the present "record" prices. Many people advocate this position. For example, Deputy Foreign Minister Viktor Kalyuzhny (who has also once served as energy minister) is certain that Russian oil firms should mostly be engaged in securing the domestic market. Considerable effort is needed here, as well as an ability to invest correctly, introduce new technologies and build new power stations. Finally, Russia's oil-refining and petrochemical industries have to be developed. Only after that should exports be boosted.

According to Vagit Sharifov, the vice-president of LUKoil, Russian oil refining is well behind most of the world. The admixture content in petrol and diesel is 3.5 times the maximum permitted level in Europe. In short, out of the 25 oil refineries in Russia (compared to the 133 in the U.S.), six were built 60 years ago and another 6 are over 50 years old, while eight plants were opened before 1960.

Russia's petrochemical industry also faces complicated problems. Refineries in Russia are major complexes that deal with organic synthesis processes. If a plant is only working to 50 percent capacity, there can be no petrochemical end products. Of course, the sector's modernization will require huge funds and effort. Exporting crude oil is far easier.

Today, 11 major and giant vertically integrated companies account for 92 percent of Russia's oil extraction and export, while more than 100 small and medium firms also operate on the market. In 2003, 421 million tons were produced and 223 million tons went for export. The Soviet Union produced 600 million tons, but had only one exporter, Soyuznefteksport. There are now more than 250 foreign trader firms, featuring sellers, more sellers, speculators and offshore fly-by-nights, in Russia alone.

The expediency of cutting or, at the very least, maintaining today's extraction rates is dictated by this factor: Russia's falling reserves. Accelerated extraction, according to Industry and Energy Minister Viktor Khristenko, will not compensate for an increase in surveyed oil reserves in Russia. This points to a serious problem. According to his information, by 2020 oil reserves will have to grow by 7.5-10 million tons. This will have to happen when all the country's major fields will have already been worked out. Those fields that are open, but have not yet been worked, are in hard to access areas in Siberia and the north.

Interestingly, Western analysts have suggested that Russia's oil reserves are considerably greater. In particular, the U.S. companies DeGoyler & McNaughton and Miller and Lents have put Yukos' reserves at 16 percent more than stated and LUKoil's at 4.7 percent. Brunswick UBS research states that Russia's oil reserves are three times bigger than was previously believed (180 billion barrels and not 60 billion). Someone seems to be highly inclined to persuade the Russians that they are sitting on a whole lot of oil that needs to be extracted...

Scenario three: Russian opts for status quo. Any increases in production and exports will only happen within the framework of state objectives -- without forcing the issue or making any great effort. This scenario gives the country the chance to take stock of the situation, review the state of the entire oil sector and tighten up legislation. The majority of experts in the Ministry of Trade and Energy are in favor of this approach, while specialists in the refining and petrochemical industries also support it.

In this scenario, Russia's optimal annual oil extraction could be 450-460 million tons in 2010, with 260-280 million tons being exported.

Each of the three scenarios has its pros and cons. Economists and advisors in the Kremlin are undoubtedly doing their sums and choosing the option that suits the country's ambitious economic plans best of all. And the winner is scenario...