- The Washington Times - Sunday, December 17, 2006

First of two parts

Above the Arctic Circle, NENETZ AUTONOMOUS DISTRICT, Russia

Lying under the tundra, thick forests and wilderness here is Russia’s wealth, the key to its future and an important lifeline for the world economy.

Russia has just begun to unlock the vast oil and gas resources of its remote Arctic and eastern Siberian plains and ocean shelves. Developing those resources will require overcoming harsh, even brutal, conditions and building costly and extensive pipelines and transportation networks to deliver them to consumers in Asia, Europe and the United States. These importers look to Russia increasingly for the fuel that keeps their cars running and the world economy growing.

Russia already ranks as the world’s largest supplier of natural gas and second-largest supplier of oil because of the giant oil and gas fields first tapped in western Siberia near the Ural Mountains in the 1960s.

But Russia is one of the few nations left that has the potential to substantially increase its contribution to fast-growing world energy needs — whether in the United States or developing countries such as China, India and Russia itself, where the use of cars is growing rapidly.

Saudi Arabia narrowly exceeds Russia’s 9.5 million barrels a day of petroleum output and also is ramping up to meet growing demand. But oil analysts say Russia has the world’s largest undeveloped reserves of oil, and no country can rival its wealth and breadth of energy resources, from oil and gas to coal, nuclear and hydroelectric power.

The unparalleled mineral resources derived from an expanse of land spanning 11 time zones has enabled Russia to emerge as the world’s energy superpower.

Russia’s rise as an energy giant began when production from the western Siberian fields peaked at 12.5 million barrels a day in 1988. But output from the aging fields collapsed with the Soviet Union in the early 1990s, and recovered only after the introduction of Western investment and technology at the end of the decade.

By 2003 and 2004, Russia’s output was growing again at double-digit rates, and its international profile as an energy superpower came fully into view.

Cognizant that the surging oil and gas sector held the key to Russia’s wealth and economic success, President Vladimir Putin in 2003 started to reassert state control over strategically important oil businesses that had been privatized in the 1990s, starting with the dismantling of Russia’s leading oil company, Yukos and the jailing of its founder, Mikhail Khordokovsky, on tax-evasion charges.

That was his opening bid to re-establish Russia as an economic power and to exploit the country’s mineral wealth to achieve broader economic and political goals. Since then, the state has consolidated control over a third of the oil sector and nearly all of the gas sector through the state monopoly Gazprom, and Mr. Putin has used the state’s power to press Russia’s interests in domestic and international political and economic disputes.

Feeling Russia’s power

Russia’s dominance as an energy provider is felt most keenly in Europe, which gets a quarter of its oil and nearly half of the gas it uses to heat homes and provide electricity through enormous networks of pipelines leading from remote oil and gas fields in Russia and Central Asia.

With Europe hooked on Russian gas, its demand for it is expected to grow by 64 percent in the next 25 years, spurred by requirements of the global-warming treaty that force it to rely on such low-carbon fuels. The European Union was instrumental in persuading Mr. Putin to sign the treaty two years ago in a stroke that served to put the treaty into effect worldwide and to deepen the continent’s energy dependence on Russia.

Former satellite countries of the Soviet Union such as Ukraine, Belarus, Lithuania and Latvia rely almost entirely on Russia for their oil and gas, giving Russia considerable leverage that it uses frequently.

Until recently they paid deeply subsidized rates — about one-fifth the prices paid by Western Europe — under arrangements dating back to the Cold War that gave Russia special trading privileges with their industries.

A year ago, Mr. Putin stirred consternation in the West by using Russia’s power for the first time to cut off gas to Ukraine and Moldova in a bid to force them to pay higher prices. The ploy generated bad publicity for Mr. Putin, but it worked. Ukraine, Georgia, Moldova, Belarus and other former Soviet states are now paying substantially more for their gas, and Russia is reaping the profit.

Michael Klare, author of “Blood and Oil,” said the incident illustrated how the world is divided into energy “haves” and “have-nots.”

In the 21st century, “possessing a rich accumulation of energy is the equivalent of a nuclear arsenal in the 20th century,” he said. “Being a ‘have-not’ creates a strategic vulnerability.”

Russia’s booming energy exports since 2001 not only have raised its status in the world but also have ignited a major revival of Russia’s economy, which fell into a deep recession in the decade after the Soviet Union collapsed. The boom today is helping to ease the poverty and social tensions that surfaced in the 1990s while renewing Russia’s confidence as a world leader.

Russia’s economy has grown at robust rates between 6 percent and 7 percent. Moscow has become the dwelling place of billionaires and a thriving middle class, the most expensive city in the world and a center of conspicuous consumption.

Soaring export earnings from oil and gas have filled government coffers, lifted flagging Russian industries and created a surge in income. The average wage in Russia has doubled since 2003, led by growth in government employment and wages, according to Standard & Poor’s Corp.

Many Russians say things are looking up for them and can recite a tale about how their life has improved.

Eugenia Chugainova, a young Muscovite who works for the Russian news agency RIA Novosti, said her mother was unable to afford chocolates when she was growing up during the 1990s in Russia’s far eastern Kamchatka Peninsula. But recently, improved economic conditions have enabled her and her family not only to enjoy chocolates but also to take vacations out of the country.

Tide lifts all boats

Russia’s government also has been a prime beneficiary of the energy boom. It reaps 80 percent to 90 percent of oil revenue earned above $30 a barrel at a time when Russia’s Urals blend of crude has been selling for about $61 a barrel on world markets.

With steep taxes on oil and gas production and exports accounting for half of government revenue, official coffers are brimming. That surplus has enabled Russia to increase pensions and wage payments, pay off its foreign debt, and amass a stunning $330 billion war chest of cash reserves and oil stabilization funds.

Oil- and government-financed construction and modernization projects are sprouting up, and a previously almost nonexistent services sector is growing briskly.

Mr. Putin hopes to further lift the living standards of ordinary Russians by using the country’s oil-generated cash to update Russia’s lagging agriculture and health sectors, improve its educational system and fund a program of low-cost mortgages for lower-income people to buy homes.

“Russia has come a long way” since its state of virtual bankruptcy in 1998, when it defaulted on its international debt and shook world markets, said Clifford Gaddy, Russia analyst at the Brookings Institution. The oil- and gas-fueled boom culminating in near-record oil and gas prices today has created “one of the most dramatic reversals of fate in recent economic and perhaps geopolitical history.”

Despite Russia’s occasional assertion of itself as a “petro-bully” in European affairs, he said, vulnerabilities lie hidden beneath Russia’s newfound strength, because the nation remains dependent on the prices of oil and gas staying high.

In addition to the dependence of the government, economic growth and many jobs on the oil and gas revenues, Russia’s energy wealth supports the economy in many other, less visible ways, Mr. Gaddy said. Russia still provides deep subsidies to its consumers, who pay one-sixth as much as Gazprom’s Western European customers for gas.

Russian industries benefit from below-market energy prices and the preference of state-controlled energy companies to use Russian products such as pipes and rail cars, even though they are not competitive with Western-made goods, Mr. Gaddy said.

Those benefits could evaporate quickly if oil and gas prices dive, as they did in the 1980s and 1990s when gluts emerged on world markets, he said.

Mr. Putin is keenly aware of how transient the country’s gains could be, and that is a principal reason, Russian officials say, why he has fortified the country’s cash reserves and is seeking to use the oil riches to bolster less favorably endowed sectors of the economy.

Toil, trouble in Arctic

If Russia’s rich resources have become the basis of the country’s strength and economic hopes, tapping into them is far from easy, as they lie within some of the most inaccessible and harsh environments on earth.

In the Arctic, among some of the most promising recently discovered oil fields near the edge of the ice-covered Kara and Barents seas, a staff of 500 year-round technicians and engineers works for Severnaya Neft or “North Oil,” a subsidiary of Rosneft, the state oil company. They brave temperatures of 40 degrees below zero or lower to keep the oil flowing.

“Our resources are very deep underground, and it’s not a good climate, like Saudi Arabia,” said Sergei Nesterenko, director-general of Severnaya, one of three international oil consortiums operating in the Timan Pechora region.

Still, he views Russia’s oil riches with pride. “It’s one of the elements that will enable Russia to reach the same development level as most modern countries today.”

Russia’s Arctic and Siberian expanses are in many ways a final frontier both for Russia and for humans living in the oil age. The winters here are so brutal that working in the fields is life-threatening and comes to a halt when temperatures drop below 45 degrees below zero.

That deep freeze happened in Russia’s Siberian and Arctic oil fields for 20 days last winter, bringing production to a standstill, much as Hurricanes Katrina and Rita stopped the flow of oil from the Gulf of Mexico in 2005.

Working in the extreme conditions requires sophisticated technologies and costly investments in plants, pipes and drilling equipment that are fortified against the cold.

But getting the liquid gold out of the ground is only the first step in a long and expensive process of getting the fuel to the cities and highways where it is consumed. Building the pipelines, ports, tankers and refineries needed to satisfy the demands of consuming nations requires at times herculean efforts and tens of billions of dollars in investment.

The Gulf Stream keeps the Barents Sea ice-free, enabling Russia to use ports at Murmansk and Arkhangelsk for loading and transporting oil and, potentially, gas in liquefied form. But the Kara Sea is frozen for two-thirds of the year, meaning any development there will have to use remote-controlled subsea production technology, which can produce oil beneath the pack ice and be funneled to market through as-yet unbuilt pipelines.

The western Siberian Arctic, where oil and gas were discovered long ago, already has a developed infrastructure, but it lies nearly 2,000 miles from major cities in European Russia and even farther from European and Asian markets. The Arctic coastline between western Siberia and Alaska is even more remote and inaccessible.

In the vast wilderness of eastern Siberia, Russia is planning to build one of the world’s longest pipelines, spanning 2,500 miles from Taishet in central Siberia to the Pacific shores so that rich reservoirs of oil can be shipped to markets in Japan, China, Southeast Asia and the U.S. West Coast.

The pipeline, to be built by Russia’s pipeline monopoly, Transneft, faces high environmental hurdles — crossing near Lake Baikal, a U.N. World Heritage Site. Once finished, the cost of transporting oil in the pipeline is expected to be high — between $6 and $10 a barrel.

How much is there?

Until pipelines are built, the amount of oil and gas lying under the largely untouched wilderness and ice of the Arctic and eastern Siberia remains only a guess. Without any means of delivering the oil to market, companies have made only limited geological surveys and exploratory efforts, and nobody can quantify how much oil is there. But many in the oil business believe the reserves are potentially immense.

The U.S. Energy Information Administration estimates Russia’s proven oil reserves at 67 billion barrels — seemingly modest at less than a third the size of Saudi Arabia’s. But a U.S. geological survey in 1998 concluded that Russia’s vast unexplored regions most likely contain undiscovered reserves of oil that are “larger than any other country in the world.”

British Petroleum, which recently signed a letter of intent with Rosneft to explore for oil and gas in Russia’s Arctic, estimates that 25 percent of the planet’s undiscovered oil and gas are within the Arctic Circle.

BP says the Arctic may hold 250 billion barrels of oil-equivalent reserve, and a further 250 billion on the Yamal Peninsula, in northwestern Siberia. If BP is correct, that supply would rival the oil reserves of the entire Middle East. In addition, a recent study by energy advisory firm Wood Mackenzie said the Yamal has massive reserves of gas. Russia already owns a quarter of the world’s known gas reserves.

One factor holding down estimates is that Russian businesses tend to be conservative in reporting reserves for tax reasons. Russia heavily taxes not only oil production and exports but also untapped reserves held by companies.

One top executive confided that with no way to transport the oil, Russian oil companies have little reason to seek drilling licenses and get an exact measure of the oil and gas underground. Any oil fields discovered would only become subject to heavy taxation by the government.

For that reason and others, energy analysts say Russia is in many ways still a sleeping giant. Some of its greatest potential contributions to world energy supplies remain dormant.

Sleeping energy giant

Beyond the huge oil and gas resources of the Arctic and Siberia, Russia has the world’s second-largest coal reserves, behind the United States. And with ample supplies of uranium, it has begun an ambitious program to increase construction and export of nuclear-power plants.

Russian officials say they have cornered about a third of the export market for nuclear power worldwide, with Russian reactors being built in India, China, Eastern Europe, Iran and other countries. At home, the government is encouraging development of advanced nuclear technology for power generation in hopes of replacing power plants that run on gas. That development would enable Russia to funnel more of its gas resources into lucrative export markets.

Russia also has enormous hidden strength in hydroelectric power, one of the cleanest sources of energy. Some of the world’s most powerful rivers surge through the Siberian plains and are untamed. By one estimate, only 20 percent of Russia’s hydro resources have been exploited. Even in populated regions, such as St. Petersburg, as much as 50 percent of hydro resources remain unused, officials say.

Russia has a ready customer in China, the world’s fastest-growing major economy, on Russia’s eastern paunch and desperate for power and exploiting every potential hydro project within its borders. Development of Siberia’s rivers is being discussed with China, but it would happen only if China agrees on a price that makes it profitable, said Russian Deputy Energy Minister Andrei Dementyev.

China is also potentially Russia’s biggest customer for oil and gas. The nation dreams of cultivating a steady, secure stream of fuel from Siberia to feed its immense and growing appetite for energy. But the cut-rate prices sought by China have caused some recent negotiations to founder. Still, Russia’s gas disputes with Europe have prompted the Kremlin to push harder on developing the Chinese frontier.

Russia has promised to construct a spur to China off the oil pipeline it is building to the Pacific coast. In March, Mr. Putin visited the country and announced that Russia would build two gas pipelines to China. Analysts say that if that compact is consummated, it could divert considerable gas from Europe to China and create possible shortfalls in Russia’s traditional Western markets.

• Tomorrow: Russia’s recent moves to seize control of strategic parts of the energy industry have slowed growth in production and raised questions about the speed of future development.

Part II

Russia rises on global oil demand

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