The Thirst for Oil

A Competitive Northern Pipeline

Workers put the final touches on a Russian natural gas pipeline
Welders work on a pipeline for Russian gas, Oct. 20, 2002 (Photo: AFP).

During George Bush’s recent visit to Russia, the U.S. and Russian presidents signed a statement on Russian-American dialogue. “We welcome the initiative of building a deep-sea port in Russia for the purpose of expanding exports,” it said.

And so on Wednesday, the top managers of Russia’s four largest oil companies—Lukoil, Yukos, Sibneft, and Tyumen Oil Co.—put their signatures to a memorandum marking the beginning of a megaproject valued at $3.5-$4.5 billion. By 2007, the companies intend to launch a new export route for Russian oil to the United States via Murmansk. And by 2010 Russian oil companies intend to hold a 13-percent share in the U.S. energy market, which fits in with the U.S. strategy of reducing dependence on Middle East oil.

Russia now exports about 5 million barrels of oil per day. Its main rival, Saudi Arabia, now exports more than 6 million barrels but, unlike Russia, it has an unused capacity to increase its exports by another 2.5 million barrels. Russia intends to increase its exports up to 10 million barrels per day, thus occupying a stable niche in the U.S. market. The Murmansk project is one of the ways of achieving such ambitions.

On Wednesday the memorandum of understanding about establishing an oil pipeline system for transporting oil via a sea oil-loading terminal in the Murmansk area was signed by Lukoil President Vagit Alekperov, Yukos Chairman Mikhail Khodorkovsky, Sibneft President Evgeni Shvidler, and Tyumen Oil Co. Executive Director German Khan. The four of them had gathered merely to talk beforehand with Russia’s president. And apparently because of that, yesterday’s meeting was labeled “the beginning of modern history.” Alekperov refused to call his partners competitors: “Everywhere we have colleagues.”

Shvidler was also brief: “I am glad that we are all together.” Khan noted that the company’s joint initiatives had been restricted by the government before. According to Alekperov, the project will help resolve the problem of insufficient transportation facilities. Russia is already increasing oil production by an average of 8 percent a year, while domestic demand is limited. At the same time, the oil companies want to set their own rates for oil transportation in a new direction and control access to the pipeline (which is now being done by the government).

Shvidler said that Transneft (all of the Russian oil pipelines are controlled by that company) President Semyon Vainstok is aware of the initiative taken by the four companies, and his company will most likely be the project operator. Transneft representatives, however, claim that nobody has approached them with such a proposal yet.

“Any idea and any project have the right to exist,” says Transneft Vice President Sergei Grigoryev. “When we receive a feasibility study and all project economic forecasts, we will be able to assess it. We have not yet seen the project details.”

Transneft does not rule out the possibility that, when the project approaches implementation, completely different figures for costs and returns may come in. Khodorkovsky also announced yesterday that Surgutneftegas, which is run by Vladimir Bogdanov, may be joining the pool. The latter, however, did not show up at yesterday’s event.

In the future it is quite possible that a number of large foreign companies will participate in the project. Yesterday, in this regard, the names of TotalFinaElf and Norsk Hydro were mentioned.

The principal funding for the project will come from Lukoil and Yukos. They will fund two-thirds of the costs related to the project and provide at least 40 million tons of pipeline capacity. All in all, the four companies now guarantee that 60 million tons of oil will be available to pump through the pipeline: 10 million will be provided by Sibneft and Tyumen Oil Co. each; they will also provide any remaining financing required. If new participants join the consortium, the parameters of the project’s share-holding arrangements can be modified. The capacity of both the pipeline and the terminal could double, reaching up to 120 million tons a year.

Two pipeline route options are now being considered: West Siberia-Ukhta-Murmansk is a 3,600-kilometer-long route, and West Siberia-Usa-Murmansk (via the White Sea) is a 2,500-kilometer-long route. The cost of the first project is estimated to be US$4.5 billion, and the other is assessed at $3.4 billion. At first the pipeline should be able to handle 60 to 80 million tons of oil per year, and then according to Yukos Chairman Khodorkovsky, it can reach as high as 120 million tons.

“Large companies are looking for opportunities to increase exports. But the project is based on a favorable market situation, and therefore the project economics somewhat recedes into the background,” says Zerich Capital Management analyst Andrei Rozhkov.

“In this context the most important thing is for the Russian oil companies to find new target markets,” says Axel Bush, an analyst at the London office of the Energy Intelligence Group. On the basis of estimates made by this group, even now Russia could export some additional 400,000 barrels of oil a year. Foreign analysts believe this initiative represents “an attack on Transneft.”

Transneft is a rudimentary organ left over from the Soviet era that will have to be reformed sooner or later, say Energy Intelligence Group analysts. Creating a competitive pipeline is a step toward that reform. Experts are confident that political support by both presidents will be instrumental in breaking Transneft’s monopoly.

“Each company will be granted the right to set the rate for its own pipeline,” says Axel Bush. But Russian analysts think that if Transneft becomes the project operator, then it will still be able to derive economic benefit and make a profit on the project, and the state will find levers to regulate oil exports from Russia.

Both Western and Russian analysts believe that the initiative taken by the four companies will not have an effect on the world market in the short run. But in the long run the situation may change fundamentally. It seems that in supporting the project the Russian government hopes that by mid-decade the Russian economy will not be so heavily dependent on oil exports and will survive a possible drop in oil prices.

It is to the government’s advantage to have oil tycoons invest capital in the development of the strategically important Murmansk port, one that has previously been of only military importance. The actual location for construction of an oil terminal is being kept confidential. “Otherwise, it will generate unhealthy public excitement, with people buying up land in that area,” explained Alekperov.