Crude oil notched yet another record high today, trading above $114 per barrel. Analysts and investors (including yours truly) have been scratching their heads in disbelief at how oil could surge to such lofty levels, even amid a global economic slowdown.
But now we know why: The world’s second-largest oil producer, Russia, is running short on oil.
Well, Russia isn’t really running dry, at least not yet. But a top oil executive at Lukoil, Russia’s second biggest energy conglomerate, just told the Financial Times that the country’s prime oil fields in western Siberia are past their peak and that “the period of intense oil production [growth] is over.”
Another Major Oil Producer with Peaking Production
This news is not to be taken lightly, since Russia is second only to Saudi Arabia in global crude oil output. Russia has been counted on this decade as a key fast-growing producer.
If you think oil at $114 a barrel sounds steep, without rising Russian output helping to offset China’s growing thirst for oil, crude would already be priced much higher.
In the wake of the economic chaos that followed its debt default in 1998, Russian oil production hit a low of about 6 million barrels per day.
Since then output has increased in each of the past ten years, aided in no small part by western technology and investment. Last year, total Russian oil production reached nearly 10 million barrels a day – a new post-Soviet high.
In the first quarter of 2008 however, Russia’s crude output slipped about 1% to just 9.76 million barrels per day. And Leonid Fedun, a vice-president with Lukoil says that Russian oil production may not surpass the 10 million barrel mark again “in his lifetime.”
Russia’s Energy Sector Wounds Largely Self-Inflicted
Of course Russia’s current oil production peak is entirely a self-inflicted wound. I have written several times in this blog about how the Kremlin routinely shakes-down western oil company investors. Companies such as BP and Royal Dutch Shell have been forced to pay “protection” to the energy mobsters of Moscow.
This typically comes in the form of “renegotiated” royalty agreements, resulting in less profits and smaller ownership stakes for the western oil company “partners.”
Moscow has also been playing a lucrative protection racket against its own oil industry.
The Russian government forces oil firms to fork over a hefty 80% of oil sales over $27 a barrel! By my calculations, the Kremlin’s “take” in 2007 alone was nearly $30 per barrel sold in pure “oil tax” income.
Now multiply that by nearly 10 million barrels a day… it’s no wonder Russia’s foreign exchange reserves are growing so rapidly!
It’s also no wonder that western AND Russian oil firms alike find very little incentive to invest in new exploration and production projects there. After all, they don’t get to see much in the way of return on investment after paying off the Moscow mob.
To Boost Production, the Moscow Mob Should Ease Up on Oil Sector
So far this year for instance, the average price of a barrel of crude is $84.70. Since the Kremlin’s take is 80% beyond the $27 mark, the government gets $46.16 per barrel in taxes alone. Meanwhile, the oil companies taking all the risk get to keep $38.54 per barrel… talk about a windfall profits tax!
Russian oil firms, including Lukoil, are pushing hard for tax reform. Under a proposal currently being discussed inside the Kremlin, the firm stands to gain back another $1 billion it could use for new projects.
But Lukoil estimates that, to reverse the current output slump, the Russian oil industry will need to invest about $1 trillion in exploration and production projects. Much of that investment would need to come from major oil firms in the west.
Loosening the Grip on Russian Oil
Vast expanses of the Russian wilderness have yet to be explored for big potential oil finds. Who knows how much possible reserves lay beneath the frozen tundra of eastern Siberia?
What’s needed is a sensible energy policy from Moscow that allows a greater profit incentive for the oil industry. What’s also needed is western know-how to help find and exploit new reserves in a cost-effective manner.
But outside oil firms haven’t exactly been given a warm and fuzzy embrace from the Russian bear so far. Instead, the Kremlin is keeping too tight a strangle-hold on Russia’s energy industry – and it’s beginning to squeeze the goose that laid Russia’s golden egg – black gold that is.
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