Russian authorities have announced that domestic oil production hit 11.36 million barrels per day (bpd), on average, in September (Vedomosti, October 2). This marks a new historic peak, reached despite the often-cited poor shape of the Russian economy and negative impact of Western sanctions, not to mention the restrictions self-imposed on Moscow by the 2016 deal with the Organization of the Petroleum Exporting Countries (OPEC) (see Jamestown.org, March 8). Commenting on this fact, Vagit Alekperov, LukOIL’s CEO and principal shareholder, assumed the current output levels cannot be sustained, arguing that Russia has already reached the limit of its oil production capacity. On the other hand, Russia’s Energy Minister Alexander Novak strongly disagreed (Neftegaz.ru, October 3).
Alekperov’s estimate should be considered with at least some degree of skepticism. First of all, such bearish assessments have been made—incorrectly—many times in the past. Back in 2005, then–deputy prime minister Viktor Khristenko predicted that oil production, at that time at 9.6 million bpd, would definitely decline after 2010 (Versia, August 25, 2016). And four years later, Mikhail Krutikhin, one of Russia’s most respected energy analysts, told Western journalists, “We now see production peaked last year,” so, “I believe the decline will continue for quite a number of years” (BBC News, April 15, 2008). Several other notable examples of suggestions that the Russian oil output had peaked could also be mentioned. And until recently, the consensus forecast for 2020 stood at 10.2 million bpd—i.e., more than 10 percent below the rate recorded last month.
Could Russia’s oil output continue to grow in the years to come? Such a scenario is certainly probable, but it will only be achieved as long as several difficult conditions are rectified.
First of all, one must look at developments not only in Russia but in neighboring countries as well. Current Russian production, though a record, is only 1.7 percent above the levels of 1989, the most successful year for the Soviet oil and gas industry. To compare, oil output in Kazakhstan was, in 2017, 3.3 times higher than in 1989; while last year’s production in Azerbaijan, whose deposits were previously considered the most exhausted in all of the Union of Soviet Socialist Republics (USSR), were 2.9 times greater than that recorded in the Azeri SSR for 1990 (Bp.com, June 2018, accessed October 17). This data proves a simple fact: output figures in the former Soviet space have depended strongly on the presence of Western technology in the domestic industry and upon the governments’ efforts to explore new oil fields in order to substitute old and overexploited ones. Of course, all this is further subject to two critical factors. The first is the global price of oil, which can make the development of the least accessible deposits profitable: if the price exceeds $120 per barrel, Russia would be able to explore and to make operational its giant Arctic oil deposits, thus adding at least 20–30 percent to current production levels (Forbes.ru, April 21, 2017). The second factor is the level of free competition between national “champions” and multinational majors: in Kazakhstan, for example, the share of foreign companies in oil production in the early 2010s exceeded 65 percent (Isc.hbs.edu, Wikipedia—Russian version, accessed October 17).
The next condition dictating whether Russian oil production levels can keep growing is the inherent efficiency of the domestic extraction industry. Even after around two decades of increasing investment, Russian oil companies still produce only 28–33 percent of oil from their wells; the average figure for British producers reaches 42–43 percent (Neftegaz.ru, December 18, 2013; Ogauthority.co.uk, September 2017). This results from the government’s policies, which do not place any strict regulations on recovery at existing deposits. Were the recovery rates to rise at least to the average level of European firms, Russia would be able to add (at least theoretically) up to 800,000 barrels to its daily output. In fact, it would also result in longer service lives for existing oilfields. The Russian government has repeatedly shown an inability to press domestic energy companies to adopt new technologies, and attempts to set tighter standards has failed many times. Perhaps the most dramatic example of the latter occurred in early 2011, when a full-scale fuel crisis erupted in Russia after low-quality gasoline was banned from the market due to the inability of the largest state-controlled company, Rosneft, to meet new government regulations (Kommersant, April 29, 2011). Related: What Killed The Oil Price Rally?
Third, Russia’s oil output has for years been held back by a lack of competition in the domestic energy market. In too many cases, private companies are banned from exploring new deposits. Illustratively, only those corporations that are majority-controlled by the state may drill offshore or in the Far North territories. Additionally, giant (or so-called “strategic”) fields can be awarded to state-owned corporations (first of all to Gazprom, Rosneft, or Gazpromneft) without obligatory auctions, and sometimes even for free (RBC, July 30, 2015). The result of these uncompetitive policies has been, in part, to keep overall production levels lower than they might otherwise have been. And another important trend worth highlighting is the fact that many state-owned companies are now trying to secure not only dominant, but monopolistic positions within the oil-and-gas-extraction sector—and monopolies, as a rule, tend to contribute to lower growth rates. For example, last year, Rosneft managed to wrest control over Bashneft, a regional company that was declared “illegally privatized” several years before. When it operated as a private entity, Bashneft increased production from 230,000 to 432,000 bpd between 2007 and 2016. However, in 2017, its production fell by 3.6 percent due primarily to the ineffectiveness of Rosneft’s management (Oilru.com, February 12, 2008; Arsagera.ru, March 21, 2018). If one takes into account that currently there are fewer than 300 oil and gas companies operating in Russia, with more than 90 percent of overall output coming from just 12 of them (in the United States, there exists more than 9,000 of such enterprises, with 54 percent of US oil and 85 percent of US natural gas produced by small independent firms) (Neftok.ru, Ipaa.org, accessed October 17), the successes of the Russian oil industry look at best quite modest.
Arguably, Russian oil production comes not due to the government’s policies, but actually despite them. Therefore, if the country chooses to embrace modern principles of state regulation and opens its oil and gas industry to foreign competition, domestic output levels will almost certainly be free to continue to grow, and quite significantly.
By The Jamestown Foundation
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