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Developments in Russian Crude Oil

Production in 2000
a
Matthew J. Sagers
a
PlanEcon, Inc. , 1111 14th Street, NW; Washington, DC 20005
Published online: 15 May 2013.
To cite this article: Matthew J. Sagers (2001) Developments in Russian Crude Oil Production in 2000, Post-
Soviet Geography and Economics, 42:3, 153-201
To link to this article: http://dx.doi.org/10.1080/10889388.2001.10641168
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Developments in Russian Crude Oil Production
in 2000
Matthew J. Sagers1
Abstract: A Western specialist on the energy industries of the former USSR examines trends
in the production of oil in the Russian Federation in 2000 and assesses developments that will
Downloaded by [University of Colorado at Boulder Libraries] at 07:45 20 December 2014
affect the sector's future performance. In addition to surveying national and regional produc-
tion trends, the paper examines the continuing evolution of the industry's organizational
structure, the dynamics of the reserve base, foreign investment activity, pricing policy and
taxation regime, legislation, and the status of production-sharing agreements. A concluding
section assesses Russian government plans for exploration and production to the year 2020.
Journal of Economic Literature, Classification Numbers: L71, Q40, Q41. 4 figures, 9 tables,
40 references.
T he Russian Federation (Russia) remains one of the world's major petroleum-producing

countries, currently ranking third in the world behind Saudi Arabia and the United
States. Since Russia has accounted for about 90 percent (more or less) of the former Soviet
oil output for several decades, when the former USSR led the world in oil production
between 1974 (when it surpassed the United States) and 1991, Russia also did. Russia is also
one of the leading oil exporters in the world, and ranks among the world leaders in oil
reserves, with an even greater oil potential.
The reform and re-emergence of this key sector are integrally linked to the country's
overall economic transformation and recovery, reflecting not only the sector's direct impact
on GDP and overall value-added in the economy, but also its importance in foreign exchange
earnings, in Russia'sfiscalstability, and in domestic energy consumption. In the current situ-
ation, raw materials extraction, particularly of fuels, figures as a key engine of economic
growth, generating vital foreign-exchange earnings and attracting foreign investment (IEA,
1995; Sagers etal., 1995).
Similar to the overall economy, however, Russia's oil sector initially experienced a
severe depression coincident with the launch of Russia's transition from a centrally planned
to a market-type economy. By 1996, Russian crude oil production had plunged to only 301.2
million metric tons (mmt), a level barely half (52.9 percent) of the peak output achieved in
1987 (of 569.5 mmt) (Fig. I).2 In 1997, production actually turned around slightly, rising by
1.5 percent (Sagers, 1997). Although the improving trend reversed in 1998 (a year of finan-
cial crisis in Russia—see Slay, 1999), as output experienced a slight dip, it then recovered
•PlanEcon, Inc.; 1111 14th Street, NW; Washington, DC 20005.

2
The production data cited in this paper for Russia as a whole or regional totals are usually taken from reports
issued by the Russian State Statistical Committee (Goskomstat Rossii, 1995, 1999,2000a, 2000b, 2001), while pro-
duction data for individual companies or enterprises are taken from published statistical reports issued by the Minis-
try of Energy—i.e., the monthly bulletins Statistika, Dokumenty, Fakty or Itogi raboty Mintopenergo (e.g., GVTs,
1999,2000).
153
Post-Soviet Geography and Economics, 2001,42, No. 3, pp. 153-201.

Copyright © 2001 by V. H. Winston & Son, Inc. All rights reserved.
154 POST-SOVIET GEOGRAPHY AND ECONOMICS
600 n
— Crude Oil Production
500
400-
300-
200
100-
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
Fig. 1. Russian oil production, 1987-2000, in million metric tons.
again in 1999 and surged in 2000. Perhaps not so surprisingly, annual trends in Russia's GDP
have tended to show a similar pattern.
The current upward swing in Russian crude oil production began in early 1999, and con-
tinued to gain momentum throughout 2000. Output growth accelerated to 7.5 percent in the
fourth quarter of 2000, compared to 6.9 percent in the third quarter, 4.9 percent in the second
quarter, and 4.7 percent in the first quarter. Overall for the year as a whole, Russian oil produc-
tion was up by 6.0 percent, to 323.2 mmt (Statistika, Documenty, Fakty, No. 2,2001, p. 68).
A number of elements were involved in producing the turnaround in Russian output, but
given that the upturn began in the second quarter of 1999, clearly the major underlying driver
for this recovery was the sharp rebound in international oil prices that occurred after March
1999, when the members of the Organization for Petroleum Exporting Countries (OPEC)—
in collaboration with some major non-OPEC producers such as Russia, Mexico, and Nor-
way—agreed to reduce their oil output and exports to international markets. The resulting
rise in world oil prices led to a substantial increase in revenues for the Russian producers,
and allowed them to increase capital spending on upstream development. At the same time,
production costs (in dollar-equivalent) for the Russian producers were reduced substantially
in the wake of the sizable devaluation of the ruble associated with Russia's financial crisis of
1998, greatly increasing the sector's profit margins.
Another dimension of the turnaround reflects a number of positive changes in the invest-
ment climate in the Russian oil industry that enabled this supply/investment response by the
producers to take place. The combination of Vladimir Putin's accession to the Russian presi-
dency in March 2000, together with the parliamentary elections of 1999 (substantially alter-
ing the composition of the State Duma, Russia's lower house of parliament), have had an
influence. The policies adopted by the Putin government with respect to the oil sector build
on some important achievements that actually preceded Putin's accession to power, such as
the beginning of tax reform (introduction of Part 1 of the new Tax Code) and passage of the
Amending and Enabling Laws to the Law on Production-Sharing (in early 1999).
The purpose of this paper is to examine recent trends in Russian crude oil production. It is
not intended as a broad survey of Russian oil sector policy or an economic analysis of the sec-
tor, although both areas must be addressed to some extent. Rather, similar to an earlier review
(Sagers, 1996), this paper mainly represents a geographically organized account of Russian
crude oil production trends, with a focus on major developments by high-profile producers.
MATTHEW J. SAGERS 155
Table 1. State-Owned Share in Major Russian Oil Companies, pet. of total shares
Company 1993 1994 1995 1996 1997 1998 1999 2000

LUKoil 90.77 80.00 54.90 33.10 26.60 26.60 16.90 14.05
YUKOS 100.00 100.00 48.00 0.07 0.07 0.07 0.07 —
a b
Sidanko n.a. 100.00 85.00 51.00 — — —
Surgutneftegaz 100.00 40.12 40.12 40.12 0.81 0.81 0.81 0.81
Tyumen' Oil Company (TNK) n.a. n.a. 100.00 100.00 51.00 49.80 49.80 —
Eastern Oil Company (VNK) n.a. 100.00 85.00 85.00 36.80 36.80 36.80 36.80
East Siberian Oil and Gas
Company (VSNGK) n.a. 100.00 85.00 38.00 0.95 0.95 0.95 0.95
Orenburg Oil Company (ONAKO) n.a. 100.00 85.00 85.00 85.00 85.00 85.00 —
Rosneft' 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00
Slavneft' n.a. 83.00 83.00 79.00 74.95 74.95 74.95 74.95
Norsi-Oi) n.a. n.a. 85.45 85.36 85.36 85.36 85.36 85.36
Sibur n.a. n.a. 85.00 85.00 85.00 14.78 14.78 —
Sibneft' n.a. n.a. 100.00 51.00 — — — —
Komi-TEK n.a. 100.00 100.00 91.95 1.07 1.07 1.07 1.07
a
n.a. = not applicable (company not in existence).
b
— = none.
Source: Compiled by the author from Statistika, Dokumenty, Fakty, No. 11, 2000, p. 82; and miscellaneous sec-
ondary sources.
OIL INDUSTRY ORGANIZATIONAL STRUCTURE
In a radical departure from past Soviet practice, when the oil industry was administered
by different branch ministries, the Russian oil industry was reorganized in the 1990s into a
few large, vertically integrated companies (VICs) that combine geological exploration, crude
production, oil refining, and distribution and retailing of refined products in one integrated
structure. These companies have been largely privatized, although the share of Federal gov-
ernment ownership in some of them remains quite sizable (Table 1), and republic-level
administrations also own substantial stakes in some of the "regional" VICs. Current plans
call for the eventual sale of most of the remaining shares still held at the Federal level to raise
funds for the budget. The interest in establishing a state-owned "national" oil company,
which has been championed periodically since 1995, has largely waned since the election of
Putin in March 2000. Currently, the Russian oil sector includes 11 large VICs. Collectively,
these large VICs accounted for 88.2 percent of national crude production and 78.8 percent of
total refinery throughput in 2000 (Table 2).
This reorganization of the industry was launched in 1992-1993, with the establishment
of the first three VICs: LUKoil, NK Surgutneftegaz, and YUKOS (Nicoud, 1996; Sagers,
1996, p. 533). Initially, a key aspect of this new structure was the creation of a new central oil
body, the Rosneft' state enterprise, to hold (temporarily) the state's shares of the oil
enterprises following their incorporation into joint-stock companies. In 1994, several addi-
tional VICs were carved out of Rosneft', including: Slavneft', Siberia-Far East Oil Company
(Sidanko), the Eastern Oil Company (Vostochnaya Neftyanaya Kompaniya or VNK), and the
Orenburg Oil Company (or ONAKO). In August-September 1995, the number of enterprises
Table 2. Russia's Major Vertically Integrated Oil Companies in 2000 a
Crude oil Natural gas Oil reserves Gas reserves Refinery Number of
Company production, production, (A + B + C,; (A + B + C,; throughput, filling
mmt bcm mmt) bcm) mmtb stations
LUKoil 62.177 3.602 3,344 289 23.196 850c
YUKOS 49.548 1.583 2,607 443 23.056 1,278
Surgutneftegaz 40.621 11.144 1,504 489 15.967 -470

Rosneft' 13.466 5.628 1,573 2,785 7.172 1,087
Tyumen' Oil
Company (TNK) 35.681 2.901 3,707 293 11.579 -200
Sibneft' 17.199 1.428 753 47 12.555 859
Slavneft' 12.163 0.715 286 50 10.826 187
Sidanko 10.689 1.305 495 78 3.671 -40
ONAKO 7.480 1.532 280 69 4.313 -70
Tatneft' 24.337 0.749 841 19 5.552 -100
Bashneft' 11.941 0.391 365 11 19.396 90
a
AU data apply to company operations only in the Russian Federation.
b
Amount of crude refined at wholly owned subsidiaries; excludes amount tolled through other plants or leased
facilities.
c
LUKoil has about 1,020 stations worldwide.
Sources: Compiled by the authorfromcompany reports; production data are from the Russian Federation Minis-
try of Energy.
remaining in Rosneft' was reduced even further, as two new VICs were formed at this time—
the Tyumen' Oil Company (TNK) and the Siberian Oil Company (Sibneft')—and assets
were added to several existing companies. Two major refineries, in Moscow and the Novo-
Gor'kiy plant near Nizhniy Novgorod, emerged from this process as essentially independent
refining companies (together with their surrounding distribution areas) without upstream
production; these refining companies are known as the Moscow/Central Fuel Company and
Norsi Oil Company, respectively. In the "autonomous" republics (Komi, Tatarstan, Bashkor-
tostan, etc.), in order to preserve their "sovereign" rights,3 regional companies were estab-
lished, consisting of the oil enterprises located within the territories of the various republics,
such as Komi-TEK, Bashneft', and Tatneft'.
The new VICs were originally only holdings with partial stakes in their subsidiaries
(usually a 51 voting stake via 38 percent ownership of common shares).4 The VICs are now
at various stages of consolidation into 100 percent ownership of the subsidiaries. LUKoil
was the first to accomplish this, with its subsidiaries ceasing to exist as independent entities
separatefromLUKoil following an exchange of stock by January 1, 1996.
Following the initial establishment of these new VICs, there has been some subsequent
consolidation among the companies. One was the acquisition of a controlling packet of
shares in the Eastern Oil Company (VNK) by Menatep Bank, leading to the merger of VNK
3
The republics' ownership of the enterprises and resources within their borders previously had been estab-
lished by the Federation Treaty or in separate agreements or decrees, with the exception of the heavily Russified
Udmurt' republic.
4
TypicaIly, a sizable proportion of the equity in any given enterprise was turned over to employees via non-
voting or preferred shares.
into YUKOS. This occurred as the state moved to divest its holdings of VNK shares in a two-
part privatization program in 1997. LUKoil also successfully negotiated the acquisition of
Komi-TEK in 1999, buying 85 percent of Komi-TEK shares from major shareholders {Inter-
fax Petroleum Report [IPR], July 2-8, 1999, p. 7). This initial stake was converted into
LUKoil shares by October 1999, essentially completing Komi-TEK's transition into a
LUKoil subsidiary (IPR, October 1-7, 1999, p. 15).
Changes have also occurred at RosnefV. Prior to 1995, plans were for RosnefV to con-
tinue as a state-owned entity that would also remain quite large, based upon its diverse hold-
ings. But this option was not followed, as more companies and assets were pulled out of the
holding. Thus, a privatization plan was approved in early 1998 to sell a controlling stake in
RosnefV to a strategic investor. But this plan, involving an international tender, failed as a
result of several problems, most importantly the overall Russian economic crisis that doused
any prospects for a sale at a reasonable price (Sagers, 1998). Following this, one plan was to
merge RosnefV with several of the smaller, weaker VICs (e.g., SlavnefV, ONAKO) then still
largely in government hands, to create an enlarged "national" oil company. But under the
Putin government, this plan has not received much support, and the remaining government-
owned shares in several of these VICs are slated for sale.
For example, in the first auction of shares in an oil company under the Putin govern-
ment, the state sold its 85 percent stake in ONAKO in September 2000. The stake was sold to
EvroTEK, a Urals-based oil trading company, for $1.1 billion in a tender that also attracted
several competing bids (IPR, September 15-21, 2000, pp. 11-12). EvroTEK is described as
an ally of TNK, as the major shareholders of EvroTEK are ZAO Renova and Alfa Group,
both also key shareholders of TNK.
Another interesting twist on this consolidation process has been the acquisition of sev-
eral of Sidanko's subsidiaries by rival companies through Russia's complex bankruptcy pro-
cedure (Fallon, 2000c). TNK was able to wrest both ChernogornefV and Kondpetroleum
(now known as TNK Nizhnevartovsk and TNK Nyagan', respectively) from Sidanko, and
Var'yeganneftegaz also was successfully poached from Sidanko.5
The principal victim of the bankruptcy process has been BP Amoco, which bought a
10 percent stake in Sidanko from the Interros group in 1997 for $571 million. Sidanko was
subsequently sued for bankruptcy in January 1999 by a little-known creditor, and was for-
mally declared bankrupt in May, allowing rival companies to take over several subsidiaries
in tainted bankruptcy auctions. BP Amoco attempted to defend its investment, but failed to
do so because of many deficiencies in the bankruptcy procedures. During this process,
Sidanko disposed of its downstream assets in Siberia and the Far East—the Khabarovsk and
Angarsk refineries and 14 product distribution companies—turning them over to Rosin vest
(Rinko) for the outstanding debts owed. Thus, Sidanko emerged from the bankruptcy process
substantially smaller than before.6
5
TNK subsequently agreed to return the Chernogorneft' asset back to Sidanko in exchange for a 25 percent
stake in the parent company. The parties are still negotiating on the conditions for this exchange, and the likelihood
of its completion is diminishing over time. Similarly, a compromise has been reached with the new owner, the Alli-
ance Group, for the return of Var'yeganneftegaz to Sidanko's control.
6
Because of BP Amoco's extremely negative experience with acquiring a minority (albeit sizable) stake in an
existing Russian oil company (Sidanko), this route for foreign direct investment in the Russian oil sector is unlikely
to be attempted by other international companies any time soon; wholesale change needs to be instituted in Russian
bankruptcy laws and corporate governance for equity acquisition in Russian companies to again become a viable
route for foreign direct investment. Indicative of this is the fact that BP Amoco recently disposed of the 7 percent
stake it inherited in LUKoil through its acquisition of ARCO.
The oil pipeline systems are not part of this "privatized" structure, but thus far remain
largely state owned;7 they function as service-for-fee carriers, serving all the various
companies. The pipelines are administered by two entities. One, Transneft', operates the
crude pipeline network, while the other, Transnefteprodukt, operates the product pipeline
network.
RESERVE BASE
Unfortunately, data on the size and location of Russia's oil reserves are still not officially
published, as such figures as still considered "state secrets." However, a number of figures
have been informally disseminated, including compilations released by the Ministry of
Energy (Ministry of Fuels until May 2000) in the form of analytical documents (e.g., Fomin,
1994). It is ironic that estimates of the volume of already discovered oil in Russia are still not
officially divulged, even though existing Russian law establishes that only 30 percent of so-
called "explored reserves" of oil are eligible for development on production-sharing terms
(see below). This ceiling is widely understood to be 6 billion tons. Thus, the total amount of
Russia's "explored reserves" would be about 20 billion tons. Similarly, Russian analytical
documents state that close to half of Russia's oil reserves have already been extracted. Given
Russia's cumulative production through 1999 of-19.5 billion tons, this implies that a similar
amount remains to be extracted (i.e., -20 billion tons).
Russian methodologies define reserves differently than Western ones, the main differ-
ence being that the Russian classification, reflecting its origins in the Soviet period, tends to
disregard the commercial constraints of economic profitability and focuses instead on what is
technically feasible under the best possible conditions (Grace, 1992). The nomenclature des-
ignates different reserve categories in descending order of geological certainty, reflecting the
degree of exploration that has occurred (i.e., A, B, C, and D). In the Russian methodology,
"explored reserves" are considered to be the sum of categories A, B, and C (A + B + C).
"Proven reserves" are defined as the sum of categories A, B, and a subset of C, referred to as
Cj (A + B + C ( ), as these comprise the quantities used to plan the level of oil and gas produc-
tion for a given field or development project. Well test or log data is required for reserves to
be certified as C, or higher. C2 reserves typically pertain to extensions of proven fields. C3/
D0 "reserves" are based only on seismic data, whereas Dj and D2 are speculative estimates of
yet unsurveyed prospects in proven or unproven petroleum provinces. To increase their
attractiveness to outside investors, the Russian oil companies now release and publicize fig-
ures on their A + B + C, reserves as well as their reserve base following audits by Western
petroleum engineering firms (see below).
For international comparisons, of course, the A + B + C, figures grossly overstate the
relative reserve position of the Russian producers. Most independent Western estimates put
Russian proven oil reserves about half of the A + B + Cj figure; a typical estimate is the 6.7
billion tons cited in BP Statistical Review of World Energy (BP Amoco, June 2000), repre-
senting 4.7 percent of the world total. In contrast, domestic reports claim that Russia pos-
sesses as much as 12 percent of the world's oil reserves. At 4.7 percent of world proven oil
reserves, Russia thus ranks well behind the big Middle Eastern producers, but would be in
between Venezuela (10.5 billion tons) and Mexico (4.1 billion tons).
7
Some shares have been distributed to employees and some plans for further privatization have been mooted.
Several Russian oil companies, beginning with LUKoil, have hired Western petroleum
engineers to re-evaluate their reserves according to Western practices. The results of these
evaluations, when compared to reported reserve figures in the Russian methodology (A +
B + C]), understandably vary substantially from company to company. But in general, the
Western-style audits report much smaller figures for "proven reserves" than the equivalent
A + B + C, measure. For example, U.S. engineers Miller and Lents estimated LUKoil's
nationwide proven oil reserves in 1998 as 10.726 million barrels (1.46 billion tons), while
LUKoil's A + B + C, total was reported as 2.1 billion tons.8
The bulk of Russia's remaining oil resources are found in West Siberia, that region cur-
rently accounting for just over two-thirds of national production. Various published sources
indicate that West Siberia contains -72 percent of Russia's remaining "proven" (A + B + C,)
reserves. However, these remaining reserves are found mostly in small, deep fields with low
permeability and complex non-anticlinal traps. The rest of the country's A + B + C^ reserves
are scattered in the mature Volga-Ural region (-14 percent); in the relatively underdeveloped
Timan-Pechora Basin in northern European Russia (-7 percent); in East Siberia, which is
geologically, logistically, and climatically difficult to develop (-4 percent); and the remain-
der (-3 percent) in offshore fields (Pechora Sea, Sakhalin shelf) and marginal older produc-
ing regions such as the North Caucasus and Kaliningrad. About three-quarters of West
Siberia's reserves are located in fields currently under development.
Among the more promising areas for future oil development is the Timan-Pechora
Basin, straddling the Komi Republic and the Nenets Autonomous Okrug (Arkhangel'sk
Oblast) in northern European Russia. It is estimated to contain 1.35 billion tons of A + B +
Cj reserves, with a yet undiscovered potential of-3 billion tons.9Although production dates
back several decades, Timan-Pechora's fields were much smaller than those in West Siberia,
and so did not receive the same intensive push during the Soviet period. As a result, the
Timan-Pechora Basin yielded just 5.4 percent of Russian oil production in 2000 (Table 3).
Other prospective areas include East Siberia and the Far East. Their potential is esti-
mated to be as high as 14 billion tons of oil, although A + B + Cj reserves (-1.1 billion tons)
are more modest because of limited exploration activity. While Sakhalin in the Far East is a
long-established producing area, most East Siberian oil fields are not yet in production. Com-
bined, this vast area yielded less than 1 percent of Russian oil output until 2000 (Table 3).
A clear trend in Russia over the past two decades has been the deteriorating structure of
the reserve base as the industry has matured. An increasing portion of remaining reserves are
falling into the "difficult-to-recover" category (55-60 percent currently) (Osnovnyye, 2000).
Over 70 percent of the reserves now being operated yield low flow rates, such that their
development is only marginally commercial. A decade ago, wells on reserves yielding flow
rates of up to 25 tons per day accounted for nearly 55 percent of total reserves in develop-
ment. At present, 55 percent of total oil reserves in development now yield flow rates of 10
tons per day or less (ibid.). This deterioration is amply illustrated by the decline in the aver-
age flow per well in Russia—this indicator has dropped from 27.6 tons in 1980 to 11.6 tons
in 1990 and to only 7.7 tons in 1999 (Table 4).
8
The figure for A + B + C, reserves is reported as 2.072 billion tons nation-wide as of December 31, 1998,
regardless of LUKoil's ownership stake. This includes 1.308 billion tons in West Siberia and 0.764 billion tons for
European Russia, according to the LUKoil website (www.lukoil.com).
9
These figures are taken from an in-depth report compiled by LUKoil on the Timan-Pechora Basin that out-
lines the company's development plans for the region (see IPR, April 28-May 4,2000, p. 12).
160
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Region 1980 1985 1987 1990 1991 199:2 1993 1994 1995; 1996 1997' 1998 1999 2000
Russian Federation 546.7 542.3 569.5i 516.2 462.3 :599. 3 353.9 3 17.8 306.S\ 301.2 305.*\ 303.3 305.2 323.2
European Russia 153.9 105.5 95.1 80.3 75.5 67. 8 60.8 :53.2 54.2; 55.2 56.S) 58.4 58.1 61.8
Kaliningrad Oblast 1.3 1.5 1.4I 1.2 1.1 1.0 0.9 0.8 0.JI 0.7 o.:1 0.7 0.7 0.7
Komi Republic 20.4 19.4 18.3t 14.6 12.8 10. 8 10.4 8.0 ) 7.4 is ) 9.6 9.5 10.2
Arkhangelsk Oblast (Nene ts
Okrug) a 1.2 1.6 1.9 1.9 2.0 2.:7 3.0 3.: $ 1.8 2.0 2.3
North Caucasus 18.8 10.8 10.1 8.6 8.1 7. 3 5.9 3.9 1 3.3 ) 3.8 3.1 3.1
Krasnodar Kray 4.6 2.2 2.1 2.0 1.9 1. 8 1.7 1.6 i 1.6 > 1.6 1.6 1.6
Stavropol' Kray 6.1 2.7 2.5i 1.8 1.5 1.4 1.1 0.7 0.' 1 0.8 0.1\ 0.9 0.9 1.0
Dagestan 0.7 0.6 0.6i 0.6 0.6 0. 6 0.4 0.3 o.:1 0.4 0.41 0.4 0.4 0.3
Chechen/Ingush republics; 7.4 5.3 4.S» 4.2 4.1 3. 6 2.6 1.3 o.:7 0.5 0."1 1.0 0.3 0.2
Volga 113.4 73.8 65.31 54.8 51.9 46. 8 41.8 38.5 40.<j 40.8 > 42.5 42.8 45.5
Tatarstan 83.1 50.8 42.S! 35.0i 33.1 30. 3 26.2 :24.2 25.: 1 25.6 25.(> 25.8 26.3 27.2
Samara Oblast 25.0 18.4 16.S» 15.1 13.9 12. 1 11.1 9.3 1 8.9 8.15 8.2 7.8 8.1
Others 5.3 4.6 5.6i 4.7 4.9 4.4 4.5 5.0 \ 6.4 5 8.5 8.7 10.2
9.1
POST-SOVIET GEOGRAPHY AND ECONOMICS
Astrakhan' Oblast 0.1 1.1 0.8 1.1 0. 9 1.1 1.2 1 1.3 I 2.7 3.1 4.6
Volgograd Oblast 3.4 2.8 2.8! 2.1 1.9 1. 7 1.7 2.0 3 3.2 1 3.9 3.6 3.6
Saratov Oblast 1.5 1.5 1.4i 1.3 1.4 1. 3 1.2 1.3 > 1.3 1.2) 1.4 1.5 1.4
2.(
Kalmyk Republic 0.4 0.2 0.3i 0.5 0.5 0. 4 0.4 0.4 1 0.3 o.:) 0.3 0.2 0.2
Ul'yanovsk Oblast 0.0 0.0 O.C) 0.1 0.1 0. 1 0.1 0.1 i.: I 0.2 o.:I 0.3 0.3 0.4
0.'
o.:
ing production and trade during the period from 1980 to 2000; most are identified in the references section. These include Goskomstat Rossii (1995, 1999, 2000a, 2000b,
Sources: Unless otherwise indicated, data in all remaining tables have been compiled by the authorfromselected official Soviet, Russian, and trade statistical compendia detail-
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3
Table 4. Average Daily Oil Well Flow in the Russian Federation, tons
1970 1980 1990 1991 1993 1995 1996 1997 1998 1999
Total 27.9 27.6 11.6 10.1 8.0 7.5 7.4 7.3 7.7 7.7
Old wells 27.3 27.0 11.3 10.0 7.9 7.4 7.3 7.2 7.5 n.d.
New wells 41.9 40.5 17.4 14.3 11.0 12.0 12.3 18.3 18.9 n.d.
Sources: Compiled by author from Goskomstat Rossii, 1999, p. 317; Goskomstat Rossii, 2000a, p. 322; and Min-
istry of Energy data.
Despite all the problems in ascertaining Russia's resource base and its ongoing deterio-
ration, what these figures clearly show is that Russia still has a huge oil potential. The ques-
tion is not whether Russia has the resource base to remain a large oil producer; rather, it is
whether the nation has the technology, organizational skills, and political unity and acumen
to develop its sizable petroleum resources sensibly and efficiently.
RECENT NATIONAL PRODUCTION TRENDS
Despite widespread fears of looming disaster for the oil industry in the wake of Russia's
economic debacle of 1998, crude oil production in 1999 actually increased slightly (+0.6 per-
cent), to 305.2 mmt (Table 3). Then, in 2000, Russian oil production surged by 6.0 percent, to
323.2 mmt. This growth was much stronger than initially expected—the Russian Ministry of
Energy's official forecast had projected that production in 2000 would even decline slightly,
to 305 mmt. The Ministry's official projection for 2001 is for production to grow by a mere
0.6 percent, to 325 mmt, even though production in the first two months of the year was up by
5.3 percent compared to the similar period in 2000. Most of the Russian oil companies, how-
ever, are projecting about 5 percent growth in national production in 2001, to about 340 mmt.
The strong surge in Russian output was largely driven by high international oil prices
(although they did begin to moderate somewhat during the fourth quarter) that boosted the
revenues of the Russian producers, which they plowed back into capital spending. Capital
investment in the upstream oil sector in 2000 more than doubled from the 1999 level in real
terms (+102.4 percent according to the Ministry of Energy), at 110.6 billion rubles (~$3.9
billion at the average exchange rate for the year) (see Fig. 2). Of this, 34.5 billion rubles
(31.2 percent of the total) was spent on drilling activity. This continued a trend established in
1999, which marked the first upturn in aggregate capital expenditures in the upstream oil sec-
tor in more than a decade. In 1999, expenditures increased by a more modest 25.1 percent in
real terms, in contrast to the significant decline registered in 1998. Investments in the
upstream oil sector amounted to 49.8 billion rubles in 1999, or ~$2.0 billion at the average
exchange rate for the year.
Increased exploration and production outlays translated into higher levels of drilling
activity in 1999-2000. Development drilling rose by 6.6 percent, to 4,596,200 meters, and
exploratory drilling increased by 8.8 percent, to 859,500 meters, in 1999 (Table 5 and Fig. 3).
In 2000, the expansion in drilling activity was even more dramatic—development drilling
increased by 80.3 percent, to 8,286,000 meters, and exploration drilling increased by
17.9 percent, to 1,014,000 meters. The number of new oil wells completed actually dropped
in 1999 by 8.5 percent, to 2,179, but in 2000 the number increased by 56.3 percent, to 3,405.
The largest contribution to the higher production level in 1999-2000 continued to come
from well work-overs, which reduced the number of idle wells to 31,940 by the end of 2000
— Investment
• • • Number of New Wells
— Drilling Activity
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
Fig. 2. Indexes of drilling, wells, and investment in Russia, 1990-2000 (1990= 100).
Table 5. Developments in Drilling Activity for Oil in the Russian Federation, thous. meters
1970 1980 1985 1990 1993 1995 1996 1997 1998 1999 2000
Total 6,998 17,394 29,205 36,166 19,523 11,002 7,789 8,005 5,101 5,456 9,300
Development
drilling 4,782 14,272 25,081 31,563 18,251 9,923 6,762 6,998 4,311 4,596 8,286
Exploration
drilling 2,216 3,122 4,124 4,603 1,272 1,079 1,026 1,007 790 860 1,014
(i.e., to only 22.5 percent of the total well stock compared to 24.2 percent at the end of 1999).
This combination of new wells and restarted old wells boosted the aggregate number of pro-
ducing wells in Russia by 7,075 during the year (i.e., January 1, 2001 versus January 1,
2000), adding over 19 mmt to annual production capacity.
"New oil," however, is also becoming noticeable again in Russia, after virtually disap-
pearing in the mid-1990s. A total of 43 new fields were brought on stream during 2000, the
largest annual number in almost two decades.10 These new fields contributed relatively little
to aggregate production during the year (a mere 546,000 tons), but the contribution of all so-
called "new fields" (those that have been in production less than 5 years) was a more sub-
stantial 16.1 mmt in 2000, or 5.0 percent of national production last year.
Although the immediate situation appears to be quite positive, many of the underlying
fundamentals in the sector remain quite poor; the transition to a market-type economy has
proven very difficult. Many of the economic and fiscal policies implemented during Russia's
economic transition have been highly unfavorable for the energy sector, particularly during
the initial phases of the reform process, although policy has tended to become more rational
over time. The fiscal burden on upstream operations was by and large based on revenues and
10
Similarly, a total of 36 new fields produced their first oil in 1999. This included 18 newfieldsoperated by the
Russian oil majors, 15 by independent Russian companies, and 3 by foreign producers. In 1998, a total of 20 new
small fields were brought on stream.
— Development drilling (thous. meters)
• - Exploration drifing (thous. meters)

Fig. 3. Drilling in the Russian oil sector, 1970-2000, in thousand meters.
not on net profit—and thus penalized exploration and production in high-cost environments,
particularly in the period prior to 1998 with the strong ruble. Also, domestic energy prices
initially remained controlled, while those for most other goods were liberalized, causing the
oil sector's production costs to skyrocket with the high rate of inflation. Furthermore, taxes
have remained oriented toward budget (as opposed to investor) needs, regulatory regimes
need to be streamlined and clarified, and access to export markets continues to be restricted.
At the same time, Russia's oil industry has undergone more liberalization and commer-
cialization than any other part of the country's energy sector. The breakdown of the old cen-
tral command structures and de-monopolization under privatization, coupled with the
proliferation of new producing entities, the formation of a quasi-market for oil domestically,
the liberalization of prices, and the (partial) liberalization of exports all point to the tremen-
dous changes that have occurred within this sector since 1991. The Russian government has
made considerable progress in clarifying the sector's administrative structure, establishing
the level of competence of different levels of authority (Federal, regional, and local), and put-
ting the sector on a firmer legal foundation. Nonetheless, all of these issues remain unsettled
and much more remains to be done. In fact, there was noticeable back-sliding on reform in
the period after 1998, particularly in the area of exports, with administrative limitations again
being imposed on crude and product exports.
While the fundamental problem in the oil industry is an economic one, partly caused by
the ongoing economic transition, objective technical factors also are important. In this con-
text, it should be noted that West Siberia first faced a "production crisis" in 1983-1985, as a
result of Soviet-style overproduction and reservoir mismanagement (Shabad and Sagers,
1987). The downward trend then was reversed (albeit for only a couple of years) through a
massive injection of financial and material resources. But after having reached an all-time
peak of 418.6 mmt in 1988, West Siberian production then plunged to less than half this level
by 1996.
Russia's prolific West Siberian oil province is very mature, although its depletion can be
attenuated by proper reservoir management and development of small and difficult fields; at
the same time, a new oil basin with reserves similar in size to West Siberia's is not on
the horizon. Thus, the key factor determining Russia's level of oil production in the future
essentially hinges on just how long West Siberia's current plateau of 200-220 mmt per year
can be maintained,11 while new reserves are put into production in less mature provinces
such as Timan-Pechora and Sakhalin. Over the longer term, new provinces such as East
Siberia, the Pechora Sea, or the Russian sector of the Caspian, are likely to make sizeable
contributions to the country's overall production profile.
The rapid growth in Soviet oil production after World War II was largely the result of the
discovery and exploitation of a series of extremely large fields. As recently as 1986, 70 per-
cent of Soviet oil production came from 20 large fields that accounted for 60 percent of
reserves (Neftyanoye khozyaystvo, No. 9, 1990, p. 4). By the mid-1990s, 82 fields (19 so-
called "giant" and 63 "large" fields) accounted for over 70 percent of Russia's production
and over 60 percent of remaining "reserves" (Finansovyye izvestiya, No. 71, July 16, 1996,
p. 5).
To offset the declines at the older large fields, production has progressively shifted to
widely scattered smaller fields, leading to increasing problems in providing needed infra-
structure and access as well as lower rates of flow. This is reflected in the fact that the aver-
age daily production per well has fallen to about a quarter of the level prevailing in the mid-
1970s. The proportion of low-yield wells (production rates of 25 tons per day or less)
increased from 37 percent in 1981 to 85 percent in 1998, whereas the number of wells with
production rates of 50 tons per day or more fell from 51 percent to 5 percent during the same
period (Osnovnyye, 2000). This has been a fundamental factor driving oil production costs
upward since the 1970s—much more drilling and much more infrastructure have been
required for smaller and smaller flows of incremental oil.
Many producing fields need modern reservoir management to (partly) remedy the dam-
age caused by Soviet-style overproduction (including quasi-systematic water-flooding). Also
needed are modern tertiary recovery techniques to maximize reservoir drainage, and forma-
tion and well treatment in less permeable reservoirs. Several alliances have been formed to
this effect between Russian oil companies and Western service companies like Halliburton
and Schlumberger, and these are beginning to show some positive results.12
Water-flooding, which has been employed in West Siberia since the very beginning to
quickly boost output to maximum levels, has resulted in an increasingly large water cut. By
1990, the water cut was 76 percent for Russia as a whole, and 72 percent for the West Sibe-
rian fields; the average had been only 50 percent as recently as 1976. Currently, water
encroachment in Russia is 70-90 percent at nearly all of the large fields. Injection of (associ-
ated) gas, which also has the advantage of reducing gas flaring, has been introduced only
slowly, and still accounted for only 1.9 percent of Russian oil production in 1999. Con-
versely, the share of oil produced from free-flowing wells dropped from 51.8 percent in 1970
to only 12.0 percent by 1990, and by 1999 was down to 8.4 percent (Table 6).
Because of these underlying dynamics, Russian oil production could only have been sus-
tained into the 1990s through a massive amount of new drilling and new field development,
certainly a questionable proposition given that the geologic structures available for drilling
"Production costs and international oil prices are crucial considerations in assessing the prospects for main-
taining West Siberia's current production plateau.
12
According to the McKinsey Report: Russian Oil (February 2001), the actual total factor productivity (the
combined measure of labor and capital productivity) of the Russian oil industry is only about 30 percent of inter-
national levels (e.g., Texas onshore production). The main reasons for the productivity gap at the operational level
are lower oil recovery (due mostly to less hydrofracturing and poor reservoir management techniques), and ineffi-
cient drilling because of the low quality of the drill bits, cleaning muds, and cement used. In an attempt to close the
productivity gap, TNK signed an exclusive deal with U.S. Halliburton to provide sophisticated oilfield services for
its fields in 1999, while YUKOS concluded a similar arrangement with France's Schlumberger in 1998.
Table 6. Oil Production in the Russian Federation by Type of Well Operation, pet. of total
output
1970 1980 1990 1991 1993 1995 1996 1997 1998 1999
Total production,
mmt 284.8 546.7 516.2 461.1 343.8 306.7 301.2 305.8 303.3 305.0
Free-flowing 51.9 53.1 12.0 11.9 10.3 9.0 8.4 7.8 8.7 8.4
Pumps 47.6 44.6 81.0 82.2 85.8 87.2 88.2 89.3 88.9 89.3
Compressors3 0.5 2.3 7.0 5.9 3.9 3.6 3.3 2.6 2.1 1.9
Other 0.0 0.0 0.0 0.0 0.0 0.2 0.1 0.3 0.3 0.4
including gas-lift.
Sources: Compiled by the author from Goskomstat Rossii, 1999, p. 317; Goskomstat Rossii, 2000a, p. 322.
35
30-
25
20
15
10
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
Fig 4. Production of "new oil" (from new wells less than five years old), 1990-2000, in million
metric tons.
also were becoming more limited. At any rate, the abrupt shift in economic circumstances
that came with the economic transition, particularly in the mechanisms for funding capital
investment, made it absolutely impossible to develop the number of new fields required to
replace the aging giants; nor could drilling rates be boosted sufficiently to offset the declines
at the older fields. In fact, the evaporation of investment led to a collapse in production drill-
ing; already by 1992 both had fallen to about half of the peak level of 1988 (see Fig. 2), and
by 1998 investment (in real terms) was a mere 24 percent of the 1990 level. Development
drilling in the oil sector by 1998 had dropped to only 4.3 million meters, compared with 31.6
million in 1990 and 36.3 million in 1988 (Table 4). Similarly, production of "new oil" in
Russia (from wells less than five years old) dropped steadily, from 33.1 mmt in 1990 to only
7.1 mmt in 1998 before finally beginning to recover in 1999-2000 (Fig. 4).
Additional needs for capital can be traced to well work-overs and preventive mainte-
nance, particularly important in Russia because of the prevalence of water-flooding. A major
cause of the decline in Russian oil production in the early 1990s was the epidemic of well
failures, particularly in West Siberia. With the shortage of investment funds, well work-over
and maintenance practically ceased in the early 1990s, and the number of idle wells soared
from 4,000 in 1988 to 23,500 in 1992, and peaked at 36,750 in 1997 (Table 7). Since then,
Table 7. Active and Idle Oil Wells in the Russian Federation3

1970 1980 1985 1990 1993 1995 1996 1997 1998 1999
b
Total wells 31,310 60,658 93,321 138,702 145,845 142,738 139,150 138,327 n.d. n.d.
Active 30,325 58,728 87,692 127,253 117,793 144,048 139,150 138,791 133,274 134,872
Giving oil 29,137 56,679 84,048 121,144 87,336 104,149 102,544 102,045 98,239 101,937
Inactive 622 1,402 4,937 9,764 30,457 39,899 36,606 36,746 35,035 32,935
Other 363 528 692 1,685 1,804 1,105 0 600 n.d. n.d.
Percent-
age idle
(inactive) 2.0 2.3 5.3 7.1 20.5 21.7 20.8 20.9 20.8 19.6
a
End of year.
*>n.d. = no data.
the number of idle wells had been reduced, but the loss of these wells from the Russian pro-
ductive well stock was a principal contributor to the overall drop in national production.
OIL PRODUCTION BY TYPE OF ENTERPRISE
In 2000, a total of 132 enterprises ("companies") were producing oil in Russia according
to Goskomstat; however, the bulk of these (110) are small, producing less than 1 mmt annu-
ally, and only 12 companies (including 10 of the VICs and Gazprom) produce more than
10 mmt per year (Goskomstat Rossii, 2001, p. 21). Although the proportion is declining over
time, the bulk of Russia's oil production is still produced by the large oil enterprises that pre-
viously were part of the former USSR Ministry of Oil: 95.5 percent in 1992 and 91.6 percent
(296.3 mmt out of 323.2 mmt) in 2000.
Gazprom remains the largest single producer outside these oil enterprises,13 but as pro-
duction by joint ventures with "foreign" companies has surged, these have now become the
largest component of production outside the traditional oil enterprises. At the same time,
there has been a proliferation of other new types of oil producers, including Russian "inde-
pendent" (or private) companies and geological exploration enterprises.
Among the various groups of producers, aggregate production rose substantially in 2000
(+8.1 percent) for the largest and more important producing group, the 11 large Russian ver-
tically integrated companies (VICs; Table 2). Their combined aggregate output amounted to
285.3 mmt in 2000, or 88.2 percent of total national output. Among the leaders in expanding
production in 2000 were: Rosneft' (+6.3 percent), Surgutneftegaz (+14.2 percent); YUKOS
(+11.4 percent); and the Tyumen' Oil Company (TNK), whose output was up by 23.4 per-
cent. The TNK figure includes the takeover of Sidanko's Kondpetroleum and Chernogorneft'
units (now TNK Nyagan' and TNK Nizhnevartovsk, respectively). Russia's largest oil
producer was LUKoil, at 62.2 mmt, with its acquisition of Komi-TEK. The second-largest
13
Gazprom's contribution to Russian petroleum output amounted to some 10.2 mmt in 1992 and by 2000 had
almost returned to this level (10.0 mmt); i.e., Gazprom has produced 2.6-3.2 percent of the Russian total during the
individual years of the last decade. Much of this would be gas condensate, although Gazprom does produce some oil
as well. Total output of gas condensate (at least that proportion of gas liquids output included in the crude petroleum
production statistics; i.e., "lease" condensate as opposed to "plant" condensate) in Russia was 9.7 mmt in 1999 and
10.4 mmt in 2000—or about 3.2 percent of Russia's total annual petroleum (crude oil plus condensate) output.
Russian producer is YUKOS, whose 2000 output climbed to 49.5 mmt following the incor-
poration of the Eastern Oil Company (VNK).
The output of the smaller, "independent" producers, which until 2000 had generally
been far more dynamic than the large VICs, included 10.826 mmt produced by small Russian
companies (+22.2 percent compared to 1999), as well as 19.105 mmt officially credited to
the foreign joint ventures (+4.6 percent compared to 1999),14 and 2.188 mmt produced by the
Khar'yaga and Sakhalin-2 PSAs (production-sharing agreements).15 Thus, "foreign" compa-
nies (the JVs and PSAs together) accounted for 21.3 mmt in 2000, or 6.6 percent of Russia's
total oil production that year.
FOREIGN INVESTMENT
Foreign direct investment has already made a noticeable difference in the structural
reform of Russia's oil sector, and thus, in the overall economy as well: in providing invest-
ment capital and funds, in transferring managerial skills and entrepreneurship appropriate to
a market economy, in technology transfer; and in promoting a competitive economic envi-
ronment. This has occurred despite the fact that the reforms needed to establish more favor-
able conditions for attracting sizable foreign investment have largely failed to materialize
with the twists and turns of the highly fluid Russian political scene.
Like the overall economy, Russia's oil sector has fared quite poorly in its efforts actually
to attract foreign investment. The cumulative amount of foreign direct investment has been
relatively small,16 both compared to Russia's potential as well as the enormous immediate
financial needs of the upstream oil sector. However, the amount of foreign direct investment
did rise significantly in 1999, to a reported $1.2 billion (~$350 million of which was by PSA
projects), after hovering at a level of only $200-300 million per year since 1994. It then
dropped back to $441 million in 2000 (Goskomstat Rossi, 2001, p. 133).
The relatively small amount of foreign investment in the sector has been ascribed by
investors to: (1) the absence of a stable and competitive legal and fiscal framework;
(2) uncertainties in property rights and rights to mineral resources; (3) an uncertain taxation
system that targets revenues instead of profits and endangers the economic viability of exist-
ing as well as planned projects; (4) export controls that restrict access to international mar-
kets; and (5) pricing policies that maintain a wide disparity between internal and external
prices for oil. Needless to say, new projects have moved only slowly and the existing opera-
tions remain reluctant to expand. The international companies have generally come away
l4
The level of foreign involvement in joint ventures (JVs) must be viewed with caution. Many allegedly "for-
eign" partners are in fact Russian-owned (although foreign-registered) companies, as they are not clearly identifi-
able international oil companies. JVs with identifiable Western partners accounted for less than half of the officially
reported total output of all JVs. The real role of Russian companies is likely to grow further, as some of them are
buying out the original foreign JV partners. This happened to several of Komineft's JVs after LUKoil's acquisition
of Komi-TEK., in which LUKoil bought out British Gas in the "Komiarcticoii" and Glencore in the "Nobeloil" joint
ventures (LUKoil Buys, 2000, p. 36; IPR, October 15-21, 1999, p. 2). Another example of this is Alfa-Eko's buy-
out of the international partner in Sakhalin-based "Petrosakh," Saudi Arabia's Nimir Petroleum (IPR, February 9 -
15, 2001). "Output" by the service JVs ("consignment suppliers") has dropped off, as many have essentially ceased
to function because of changes in rules regarding their operations, especially the right to export on their own
account. As recently as 1995, the service JVs had an "output" of 6.8 mmt.
I5
The first oil from two production-sharing (PSA) projects—Sakhalin-2 (Sakhalin Energy Company) and
Khar'yaga (TotalFina-Elf/Norsk Hydro)—was realized in 1999. That year Sakhalin-2 produced 143,500 tons and
Khar'yaga, 72,300 tons. In 2000, Sakhalin-2 produced 1,642,080 tons while Khar'yaga produced 515,480 tons.
16
By the end of 2000, cumulative FDI amounted to only about $4.0 billion.
from the experience of the past decade in a fairly somber mood. Clearly, it is going to take
sustained effort and consistent policies for a considerable period on the part of the Russian
government to convince international companies to invest any sizable sums.
The dominant vehicle used for foreign direct investment in the Russian oil sector has
been the joint venture. But the first oil under production-sharing contracts was obtained in
1999 from two projects—Sakhalin-2 and Khar'yaga (see above). However, these projects
were signed before the passage of the PSA Law in 1995, and so their contracts were "grand-
fathered" (recognized) by that legislation (see below). The Sakhalin-2 project became opera-
tional in 1996, and investment since then has totaled $1.25 billion. Total investment in the
Khar'yaga project has been about $100 million since its effective date in January 1999.
Besides these two producing projects, the Sakhalin-1 project also dates its implementation
from 1996. But Sakhalin-1 is still several years away from production, with investment total-
ing only about $250 million since implementation. It is estimated that over the (20-year)
lives of these projects, Sakhalin-1 will require about $13 billion in investment, Sakhalin-2
about $10 billion, and Khar'yaga about $700 million.
INVESTMENT ENVIRONMENT:
PRICING POLICY, LEGISLATION, AND TAXATION
In terms of the key aspects of reforms that affect the overall investment environment in
the Russian oil sector, there has been considerable backsliding since 1998. Although some
progress was made in legislation, on other key fronts—oil pricing policy, oil taxation policy,
and oil export policy—the situation regressed during the period. In many instances, positive
steps achieved previously were quickly reversed.
Oil Pricing Policy
Oil pricing in Russia became largely market-determined after September 1992, when
partial liberalization was introduced, and in January 1995, crude prices were finally com-
pletely liberalized, followed by liberalization of oil product prices in March 1995. Between
1992 and 1998, the government's influence on the domestic oil market gradually waned and
the market continued to liberalize. Most domestic sales of oil and refined products came to
be negotiated between buyer and seller. A further element in liberalization occurred in April
1994, when producers were formally given the right to cut off delinquent customers. In con-
trast, since 1998, the government has attempted to regain some of its influence on the domes-
tic oil market through a number of mechanisms (e.g., domestic delivery requirements for
both crude oil and various refined products, pricing pacts with the oil companies, restrictions
on exports).
Reflecting the broad changes in policy over the past decade, domestic oil prices
increased in relative terms through 1998, although not consistently. At the same time, domes-
tic prices generally moved closer to parity with international levels. The average domestic
crude oil price advanced from less than 1 percent of world levels in December 1991 to actual
parity with international prices in the first quarter of 1998 (aided somewhat by a substantial
decline in international prices at that time).
Much of the realignment occurred during the period after the elimination of the export
quota system and lifting of the price caps in early 1995. Domestic prices immediately began
to find their own level as a result of domestic market forces, without the interference of the
"cost-plus" restrictions previously in place. By the end of 1995, domestic crude prices had
already reached 54 percent of international levels. But in 1996-1997, domestic prices stalled
at about 60 percent of international levels. It was only after the elimination of so-called
"state" exports in the third quarter of 1997 that domestic prices were finally able to fully
close the parity gap.
One of the mechanisms by which the government continued to manipulate domestic
prices after 1995 (when prices and exports were liberalized) was through government pur-
chases for "state" exports. The growing volumes of state exports acted as a major factor
holding down the domestic price of crude before their elimination in July 1997. This was due
both to the restrictions on export capacity for producers that these represented, as well as the
role of the state as the largest single purchaser of crude oil. State exports have since made a
re-appearance, resuming under the Primakov government.
In the aftermath of the sharp devaluation of the ruble in August 1998, the average Rus-
sian domestic crude oil price dropped from near equality with international (export) prices in
the first half of 1998 to only -40 percent of export prices in the second half of 1998 and into
1999. But with the rapid run-up in international prices that began in the second quarter of
1999, domestic prices weakened relative to international parity, and in the third quarter
amounted to only 28 percent of the international price. The average domestic price finally
began to gain ground in the fourth quarter of 1999 and 2000, reaching about 41 percent of the
international price by the end of 2000.
Besides the inevitable lag in adjustment on the domestic side to the rapid run-up in inter-
national prices, other factors have acted to restrain domestic price adjustments. One is the re-
imposition of administrative limits on exports (of both crude and refined products), deliber-
ately intended to keep the domestic market oversupplied and relatively slack; others include
the export tax and the resumption of state exports. Although the adjustment in domestic
crude prices has been quite slow since August 1998, the overall direction has been unambig-
uous—upward, toward closing the gap with international prices.
A factor further distorting the domestic crude market and keeping the average domestic
price level down is the widespread use of transfer pricing within the VICs. This is largely
done to minimize taxes, since so much of upstream taxation is based on gross revenues. Also,
a high percentage of crude deliveries occurring outside the VICs is made on a tolling basis,
further reducing the amount of crude sold domestically on a truly commercial basis. Accord-
ing to the estimates of Russian experts, only about 8 mmt of crude is sold domestically on
commercial terms in the domestic market, or less than 3 percent of the total amount produced
{Krasnoye znamya [Tomsk], May 25, 2000).
A key element of oil pricing policy is the export tax, which essentially serves as a wedge
between domestic prices and international prices. After being absent for two and a half years
(from July 1996), the Primakov government re-introduced the export tax in January 1999,
referring to it as a "devaluation" tax to capture some of the gains of the exporters in the wake
of the ruble devaluation.
It was actually suspended in the first quarter of 1999, however, due to low international
prices, as it varies with the world market price. But following the rise in international prices
in March 1999 with the OPEC agreement, the export tax on crude oil was instituted at a level
of 2.5 euros per ton on April 24, 1999, and was progressively increased to 5 euros (June 22,
1999), 7.5 euros (September 23, 1999), 15 euros (December 8, 1999), 20 euros (April 1,
2000), 27 euros (August 2, 2000), 34 euros (November 4, 2000), and then 42 euros per ton
(December 19, 2000). The government then reduced the export tax because of lower inter-
national prices, in March 2001, to 22 euros per ton.
Legislative Framework
Over the past decade, a number of important laws were passed relating to the hydrocar-
bon sector, and several important pieces of legislation are still pending. The key oil-related
legislative acts include: the Law on Underground Mineral Resources; the Oil and Gas Law;
the Law on Concessions Agreements; the Law on the Continental Shelf; the Law on Produc-
tion Sharing; the Law on Natural Monopolies; and the Law on Trunk Pipelines.
The first of these to be adopted was the law on mineral resources (known as the Subsur-
face Resources Law or Law on Underground Mineral Resources). This legislation, establish-
ing a legal framework for all mining operations (including petroleum production), was
passed by the Russian parliament in February 1992 and became law in May 1992. Its most
important feature is that it establishes "the state" (implying the Federal government, although
this was deliberately vague) as the exclusive owner of all mineral resources, but allows pri-
vate and state-owned entities to lease exploration and production rights from the state via
licenses. The Law on Underground Resources requires that licenses be issued only through
public competitive tenders. Subsequently, in July 1992, regulations were issued on the proce-
dures for licensing the use of the subsurface, establishing that the Federal body responsible
for issuing licenses is the State Committee for Geology and the Use of Underground
Resources (now Ministry of Natural Resources), although a "two-key" approach was
adopted, requiring this to be done jointly with the relevant regional body. Licensing and ten-
dering have since become the major tools used by the regional administrations in regulating
the development of hydrocarbons in their territory.
A number of subsequent amendments to this Law have been passed. Among the more
recent was one signed by Vladimir Putin during the period when he was Acting President, on
December 1, 1999. These latest changes concern the terms for use of deposits, the basis for
receipt of licenses to deposits, and tenders and auctions on resource use, as well as rules on
transfer of licenses. The latter was particularly a high priority because of the need for
licenses to be transferred from the subsidiaries to the central holding within integrated com-
panies, as well as the need for license transfers from one company to another arising from the
acquisition of subsidiaries by rival companies.
Work also proceeded on a law dealing more specifically with the procedures and condi-
tions related to hydrocarbon production, processing, and transport (the so-called Oil and Gas
Law). This law was designed to complement the 1992 Law on Underground Resources by
establishing new (and in many cases more restrictive) licensing and operating rules for the oil
and gas industry. It specifically covered oil and gas extraction, pipeline transportation, geo-
logical surveying, and underground storage. Although considerable importance was attached
to enacting definitive petroleum legislation that would provide a comprehensive, clear, and
stable legal framework for petroleum operations, this has not occurred. The State Duma
adopted the Oil and Gas Law in July 1995, but the legislation was not endorsed by the Feder-
ation Council and the President. The impetus behind it essentially lagged in the press for pro-
duction-sharing legislation and improvements to the existing Law on Underground Mineral
Resources.
The Law on Concessions Agreements, which relates to mineral resource extraction
issues in general, where the output of the mineral product is divided between the operator
and the government, failed even to clear the State Duma. This legislation could possibly have
reduced the potential for discrimination against foreign investors and made the state and
investors equal partners in contract relations. This bill was intended as a framework law,
which, along with a production-sharing law, would address problems regarding investor
rights and relationships. However, the last mention of this legislation was in February 1995,
so it appears to have fallen by the wayside as well.
In October 1995, after considerable changes, the Law on the Continental Shelf was
passed by the State Duma and subsequently signed into law by former President Yel'tsin.
The changes initiated by Yel'tsin affected the delimitation of the continental shelf and gave
Federal authorities exclusive rights to permit and regulate exploration and development of
the shelf by either foreign or Russian investors after tenders and auctions. It also includes
protective measures to defend Russia's exclusive rights and jurisdiction in the zone. Russia's
jurisdiction on the shelf applies to the exploration and production of mineral resources, the
construction of facilities for drilling, and the laying of cables and pipelines.
Another important piece of legislation is the Law on Natural Monopolies, which went
into effect in August 1995. This Law regulates the so-called "natural" monopolies, and as
such covers many activities in the Russian energy sector. This Law defines companies such
as Transneft', Gazprom, Unified Energy Systems (UES), and Transnefteprodukt as natural
monopolies, and therefore their activities fall under its purview. The Law provides for the
establishment of state monitoring or regulatory bodies over these monopolies (Anti-Monop-
oly Ministry and Federal Energy Commission). A series of subsequent government resolu-
tions were issued outlining the organization, operations, and powers of these bodies.
The Law on Trunk Pipelines, which has been under consideration in the Duma for some
time, is another important part of the legislative framework for oil and gas. Work on this leg-
islation dates back to 1994-1995, resulting in several different drafts—one prepared by the
pipeline operators (Transneft' and Gazprom), one by the Ministry of Energy, and one by the
Duma itself. The earliest draft of the Law was forwarded to the Ministry from the companies
in mid-1997, while a working group in the State Duma (Committee for Industry, Construc-
tion, Transportation, and Electric Power) drafted its own bill in April 1999. It was this draft
that subsequently was approved on its first reading in the Duma in September 1999.
However, this draft has since languished within the Duma, partly because of the diver-
gent aims advocated by the various interests, although its passage was one of a number of
measures that the government agreed to implement in the oil and gas sector in order to secure
release of the third tranche of a $1.2 billion economic restructuring loan from the World
Bank (in May 1999). The World Bank required that this Law contain provisions on non-dis-
criminatory access and tariffs as well as restrictions on vertical integration across oil extrac-
tion, transportation, refining, and distribution. But the draft also includes language requiring
state ownership of a controlling (blocking) stake in any pipeline transportation system on
Russian territory, and also ensures the indivisibility of existing pipeline transportation sys-
tems. As such, the draft law effectively prohibits the break-up of the existing pipeline
monopolies. Other language in the bill ensures that independent producers have guaranteed
access to all pipeline systems, even those belonging to non-monopolist providers; i.e., inde-
pendently built pipelines.
Production-Sharing Legislation
Another major legislative thrust has been in the area of production-sharing agreements
(PSA).17 This investment form dominates much of the world's oil industry outside the OECD
17
In the most general sense, a PSA is a contract between a developer and the government, whereby the devel-
oper obtains revenues from sales of the product and splits these with the government in the manner prescribed in the
contract.
countries. A key attraction of the PSA regime for investors lies in the fact that it replaces any
energy-specific taxes and eliminates many uncertainties about future tax rates and rules, as
the division of profits between the company and the state becomes the subject of the produc-
tion-sharing contract that extends over the life of the project. Production-sharing contracts
have proven attractive to both investors and governments in many countries because the
structure is responsive to cost (rewarding the operator for reducing costs) while the rate of
taxes on profits is progressive, thus ensuring that the state receives an increasing share of
higher rates of profits.
Because of its nature as a long-term contract between the investor(s) and the host gov-
ernment, PSA provides several other important benefits that reduce general risk for the
investor(s) and major lending and financing institutions currently lacking in Russia. This is
the main reason that establishment of an effective PSA regime has become such a high prior-
ity for international oil companies—in their view, only a PSA regime can provide the long-
term guarantees necessary for large-scale investment. The Russian legal and fiscal frame-
work has proven to be so volatile over the past decade that it will take a considerable period
for confidence to be built up in any alternative legal and fiscal arrangements, no matter how
well designed.
Thus, passage of PSA legislation forms an important part of efforts to create a business
environment capable of attracting large-scale foreign and domestic investment into Russia's
oil industry, but interest in getting this accomplished has waxed and waned over the years.
Until the 1998 financial crisis, many politicians and officials opposed PSAs, and the realiza-
tion of the PSA regime was quite slow. The opponents cited many issues, claiming that it
gave away Russia's "sovereignty" and control over its mineral resources, or that PSA's spe-
cial tax regime represented "losses for the budget," or that the PSA was only a framework for
Third-World countries.
Rather slowly the opponents came to realize that such concerns were largely unfounded.
Increasingly, they began to understand that: (1) experience in many countries shows that
investors regard PSA as a workable mechanism upon which major investments can be based,
especially during the period when an overall legal and tax regime is being put into place, and
while confidence is slowly growing in it; (2) PSAs do not take away the government's sover-
eignty and control over mineral resources; the license owner still has to meet the terms of the
PSA agreement or the license can be revoked; PSAs, however, do protect the investor against
unilateral arbitrary decisions by the state; and (3) PSAs do not constitute a special tax regime
representing losses for the budget; PSAs do, however, provide predictability and protection
for the investors) against new or retroactive taxation; thus, revenues to the state from PSAs
cannot be compared to revenues under the current tax system because under the current tax
system these projects would be either rendered uneconomic or have high risk and therefore
not be realized at all.
Many large "mega-projects" in Russia, as well as a host of smaller projects, remain con-
tingent upon establishing a workable PSA framework before they can proceed. For large-
scale projects, foreign investors insist upon the long-term stability in investment conditions
guaranteed by PSA. Also, after long being viewed primarily as a vehicle for foreign invest-
ment, PSAs are now widely recognized as useful for domestic Russian companies in stimu-
lating their own investment in large upstream projects.
Russian legislators and officials hope that the completion of the PSA regime will
"unlock the floodgates of foreign investment," a flow that thus far has been stymied by a host
of political, legal, and fiscal issues. The Ministry of Energy estimates that Russia could
attract up to $80 billion in foreign investments in the next decade if the PSA mechanisms
were to be properly implemented.
Russia's original Law on Production-Sharing (PSA Law), which went into effect at the
end of 1995, was intended as a framework law implementing or confirming the executive
order issued by former President Boris Yel'tsin in December 1993.18 But the Law underwent
many changes and compromises during the legislative process. As a result, it was roundly
criticized in its final form as being too diluted to be significant. Nevertheless, this was the
version adopted by the State Duma on December 6, 1995 and approved by the Federation
Council on December 19, 1995; it was subsequently confirmed into law by former President
Yel'tsin on December 30, 1995.
Given its many internal contradictions and incompatibility with existing laws as well as
the draft Tax Code, an "enabling law," effectively harmonizing PSA with all the laws and
regulations it affected (e.g., tax laws, customs laws) had to be enacted to put the PSA Law
into effect. Other amendments to the original PSA Law also were needed. Another require-
ment of the original PSA Law was that all new PSA contracts had to be approved by the Rus-
sian parliament (State Duma). This occurs through a law (or set of laws) specifying which
fields or deposits are eligible to be developed on PSA terms (the so-called "list laws"). These
key implementing laws remained essentially locked in the Duma during 1996-1998. ,9 The
August 1998 financial crisis imparted policymakers and Duma deputies with a sense of
urgency concerning the need for effective implementation of the PSA Law to provide the
basis for attracting foreign direct investment to Russia's natural resource sector. Some also
consider the accession of Yevgeniy Primakov as Prime Minister (a man more trusted by the
Duma), as a key factor breaking the logjam in the Duma over PSA legislation.
Thus, in December 1998, a package of amendments to the PSA Law itself and the appli-
cable individual tax laws were passed by the Duma and entered into force in early 1999.
More specifically, these were the PSA Amending Law, which became effective on January
14, 1999, followed by the Enabling Law on February 17, 1999. These changes in the basic
PSA Law improved it considerably, although they also introduced some new restrictions.
One was a 30 percent ceiling on the portion of reserves eligible for development on PSA
terms. Another amendment to the PSA Law was a 30 percent limit on foreign-made equip-
ment that may be used in PSA projects.20
Another change that went into effect in 1999 was that agreements involving fields with
reserves of less than 25 mmt no longer required explicit Duma approval; they require only
approval of the Federal government and regional authorities. This was an important aspect of
a compromise with regional authorities that established the pre-eminence of Federal law in
PSAs, but allowed the regions to conclude PSAs on small fields without passage of separate
Federal legislation. Previously, several regions (such as Khanty-Mansiysk and Tatarstan) had
passed their own PSA laws that often contradicted Federal legislation, as they attempted to
implement PSA projects on their own.
18
This was during the interval between the dismissal of the old parliament in September 1993 and the conven-
ing of the newly elected one under the new Constitution.
l9
This was the period when the government was in the hands of reformers, but the Duma was dominated by the
Communists.
20
lt is still not clear whether the limit refers to every article or can be applied in aggregate over the life of the
project. Investors favor the second interpretation, as it makes sound economic sense to increasingly use Russian
equipment and labor to reduce costs. The concern is that some Russian equipment does not meet international stan-
dards at the present, and this could delay investments if imported equipment cannot be used instead.
In addition, several laws have been adopted that currently list 21 hydrocarbon fields/
blocks as being eligible for development on production-sharing terms (Table 8). The first of
these laws, passed in July 1998, included five hydrocarbon fields—Prirazlomnoye (offshore
in the Barents Sea), Samotlor and Krasnoleninskiy (Khanty-Mansiysk Okrug/Tyumen'
Oblast), Romashkino (Tatarstan), and the northern Sakhalin block. Subsequent laws include
the Kirinskiy block, located in Sakhalin's offshore shelf (signed by former President Yel'tsin
in April 1999), and another listing Luginets (Tomsk Oblast), Fedorovo, the Uvat block, and
Salym (in Tyumen' Oblast) and Usinsk, South Lyzhskoye, and North Kozhvinskoye (in the
Komi republic), the Udmurt block, and the Yurubcheno block (Krasnoyarsk Kray in East
Siberia), which was signed by former President Yel'tsin into law in May 1999. This was fol-
lowed by laws listing northern Priobskoye (West Siberia) and the Northern Territories block
(Timan-Pechora) in November 1999. More recently, one law was signed by Vladimir Putin
(as Acting President) in January 2000, for the Vankor field (northern Krasnoyarsk Kray, in
East Siberia). Putin also signed laws in October 2000 that made the Komsomol'sk, Kharam-
pur, and Tyanskoye fields (in West Siberia) eligible as well. The most recent such law
was signed in March 2001, which made the Kovyktinskoye gas field in Irkutsk Oblast eligi-
ble for PSA status. Other list laws remain in play, including ones to make fields such as
Skhtokmanovskoye (Barents Sea) and North Astrakhan' (Astrakhan' Oblast) eligible for
PSA status.
Even so, the legal and regulatoryframeworkfor PSA is still incomplete, despite the fact
that more than five years have passed since adoption of the original PSA law and two years
since the related enabling laws went into effect. Foreign investors remain concerned over
several issues that need to be addressed in greater detail through government regulations and
other legislation. These include issues related to definition of tax responsibilities, what costs
would be recoverable and methods of their calculation, the application of international law in
contract disputes, the procedure for transferring mineral rights, and lingering export limita-
tions. One provision worrisome to foreign investors allows the Russian government to unilat-
erally renegotiate the terms of a production-sharing agreement in the event of a "substantial
change in circumstances," although what constitutes such a change has remained undefined.
In addition, the contradictory nature of many aspects of the PSA Law leaves wide room for
differing interpretations and the potential for conflicts.
A key fact attesting to the limitations of the original PSA Law is that not a single new
PSA with foreign investors has been signed and implemented since its passage in 1995.21
The only PSA projects that have been able to make any significant progress are those actu-
ally signed before its passage and were thus "grandfathered."22 Even so, the multiple prob-
lems encountered by these "grandfathered" projects (particularly Sakhalin-1 and Sakhalin-2)
21
A partial exception is the PSA on the Prirazlomnoye offshore field in the Barents Sea. A memorandum on
this project (estimated to require $1 billion in investment) was signed between Germany's Wintershall and Gazprom
on June 15, 2000 during a visit by President Putin to Germany {Summary of World Broadcasts [SWB], June 23,
2000; Oil and Capital, No. 6, 2000, pp. 20-21). But an actual PSA remains to be signed between the two investors
and the Russian government. This is planned to occur during 2001.
22
Even a PSA concluded with a domestic investor (TNK) has stalled. A PSA agreement on the Samotlor oil
field, which is an older, mature field that has been in production for over 30 years, was signed on December 24,
1999 by TNK, the Federal government, and the Khanty-Mansiysk regional administration. But the PSA cannot be
implemented because of numerous conflicts with other laws and regulations, such as its provision for 100 percent
exports. To break through the legal bottlenecks, TNK has proposed a simplified, alternative version of the PSA law
that establishes a straight negotiated split of physical production between the developer and the state. Such an inflex-
ible arrangement would be totally unacceptable to foreign investors, however.
Sakhalin Energy (Shell, Mitsui,

ExxonMobil, Sodeco, ONGC
Totalfina-Elf, Norsk Hydro

Mitsubishi)
TB Com AG
Wintershall
Russian partner(s) Foreign partner(s)
Shell
"Grandfathered" projects (agreements signed before adoption of the PSA Law)
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Table 8. Russian PSA Projects: Implemented or Authorized
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Location
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S. Lyzhskoye, North Kozhva

(Block-15) Komi Republic 28 n.d. Parmaneft'
Udmurt block Udmurt Republic 50 Samson International
Yurubcheno-Tokhomskoye Evenk Okrug (Krasno-
yarsk Kray) 281 n.d. East Siberian Oil
Uvat block Khanty-Mansiysk Okrug 68 $1.3 Uvatneft' (Tyumen' Oil Company)
Fedorovo Khanty-Mansiysk Okrug 264 n.d. Surgutneftegaz
Luginets Tomsk Oblast 26 n.d. Tomskneft' (VNK/YUKOS)
Kirinskiy block (Sakhalin-3) Sakhalin Oblast 687 n.d. Rosneft', Sakhalinmorneftegaz ExxonMobil, Texaco
Northern Territories block Nenets Okrug 440 $5.0 LUKoil, Arkhangel'skgeoldobycha Conoco
Tyanskoye Khanty-Mansiysk Okrug 26 $3.5 Surgutneftegaz
Vankor Krasnoyarsk Kray 125 $3.3 YeniseynefV Anglo-Siberian
Kharampur Yamal-Nenets Okrug 118 $3.2 Rosneft', Purneftegaz
MATTHEW J. SAGERS
KomsomoFsk Yamal-Nenets Okrug 120 $1.9 Rosneft', Purneftegaz Shell

Priobskoye (northern block) Khanty-Mansiysk Okrug 676 $23.2 YUKOS
Kovyktinskoye Irkutsk Oblast $ 9.0 Rusia Petroleum BP Amoco
177
during implementation have been enormous, and highlight the need to streamline and clarify
ambiguous and often conflicting and outdated regulations, especially in the area of environ-
ment and safety. For example, over a thousand different approvals were needed for the
implementation of just the first phase of the Sakhalin-2 project.
With recent changes in the parliament and presidency, political forces in Russia are now
aligned, such that the prospects for completion of the PSA regime look particularly hopeful.
In an effort to streamline and carry out the work needed to effectively implement the PSA
Law, President Putin recently transferred monitoring and implementation responsibility for
PSAs from the Energy Ministry to the Ministry of Economy and Trade under German Gref,
the chief architect of his overall economic reform program.
Investors are hopeful that this bureaucratic streamlining, bringing the responsibility for
effective implementation of PSAs under the guidance and coordination of the Ministry of
Economy and Trade, will mean the quick passage of acceptable "normative acts" needed to
interpret and flesh out the PSA Law and make it operational. A significant breakthrough
occurred in the thrust to get the normative acts completed when President Putin strongly
endorsed the need for these to move quickly in September 2000 at an international confer-
ence on PSAs in Sakhalin Oblast.
These 16 normative acts include those addressing the corporate profit tax, VAT, the pay-
roll tax, royalties, customs duties, and regional, local, and other taxes. A particularly vexing
problem is that no procedures or regulations exist for the determination of which costs are
recoverable by the investor before profit share is determined. These normative acts also
include investors' rights to unrestricted currency operations and investors' rights to extract,
transport, and export their production. These acts also must establish that production-sharing
will take precedence over any new laws passed in the future.
Tax Policy
In its present form, the Russian oil taxation system has several major defects. One is its
complexity—there are too many different kinds of taxes; the number of taxes and payments
collected from oil companies into Federal, regional, and local budgets now numbers nearly
100 in some regions. Another shortcoming is its instability; the high variability of tax policy
over the last decade has made it extremely difficult to carry out a business plan or invest.
Third, the existing Russian oil taxation system is excessively based on gross revenues, or
production volumes, rather than based on profits. As a result, taxation remained insensitive
to the distressed financial condition of oil producers when oil prices were low or to the cur-
rent conditions when international prices are at near-record highs.
The risk of fiscal change is a major concern to investors making large up-front invest-
ments, especially in countries like Russia, with little or no history of fiscal stability. Frequent
tax changes are inherent in gross revenue-based regimes where governments need to make
periodic adjustments to benefit from changes in prices or costs. Profit-based systems are
inherently more self-adjusting and give a better basis for investors to assess the fiscal impact
over the life of their investment project. Furthermore, such systems do not impose a heavy
tax burden in the early years of production (which would negatively affect the projected rate
of return). Taxation policy that seeks to maximize short-term government revenue may jeop-
ardize the long-term economic goals of attracting investments, providing long-term employ-
ment and income, and widening the tax base. Finding the right tax structure is of particular
importance to Russia, where the oil industry has accounted for 20-23 percent of Federal gov-
ernment revenues in recent years.
Table 9. Calculation of Crude Oil Prices, Taxes, and Costs (pro forma), in dollars per tona
June 1998 June 1999 June 2000

Price/tax/cost Domestic Exports to Domestic Exports to Domestic Exports to
sales non-FSU sales Non-FSU Sales non-FSU
Refinery input price/export
price 75.2 91.9 25.7 112.0 60.0 199.0
Transport to refinery/
export point 6.1 17.1 3.3 11.0 2.9 10.2
Export tax — — — 4.9 — 19.7
Domestic wholesale price/
net export price 69.1 74.9 22.4 96.1 57.1 169.2
VAT (21.5 percent) 12.2 — 4.0 — 12.3 —
Excise tax 9.0 9.0 2.3 2.3 1.9 1.9
Suppliers price 47.8 65.8 16.2 93.8 42.9 167.2
Government funds and
charges (total) 46.3 48.1 3.7 10.5 8.6 19.6
Royalty (10 percent) 38.3 38.3 1.3 1.3 3.4 3.4
Geology fee (8 percent) 4.8 6.6 1.6 9.4 4.3 16.7
Geology fee (recovery
4 percent) 1.9 2.6 0.6 3.8 1.7 6.7
Road users tax
(4 percent) 1.2 1.6 0.4 0.4 1.1 1.1
b
Other taxes 3.3 3.3 0.8 0.8 0.9 0.9
Production costs
(sebestoimost ')c 39.6 39.6 11.5 11.5 8.5 8.5
Gross profit for crude oil
producer -38.1 -21.9 0.9 71.8 25.7 139.1
Corporate profits taxd 0.0 -7.7 0.3 21.5 7.7 41.7
Profit after tax -38.1 -14.2 0.6 50.3 18.0 97.4
Government take (percent
of gross revenues) 89.9 53.8 39.8 35.0 50.9 41.7
Government take (percent
of net revenues) 819.7 188.6 220.0 41.7 88.9 39.9
a
For average Russian crude oil producer.
b
Other non-revenue taxes, including property tax and social taxes, not included in operating costs.
including depreciation.
d
35 percent through February 28, 1999; 30 percent thereafter.
The existing Russian tax structure showed signs of these shortcomings in 1998, when
international oil prices were depressed to record low levels, putting the Russian producers in
a severe squeeze as revenues dropped. It really was only the substantial devaluation of the
ruble after August 1998 that eased their financial plight. The sector's financial health subse-
quently materially improved with the rapid increase in international prices in 1999-2000.
A third problem is that the tax "take" is much too high. As shown in Table 9, the govern-
ment tax "take" was more than 100 percent of net revenues for the average Russian producer
in June 1998 on both domestic sales and exports; even in June 2000, with international prices
at near-record levels, this had fallen to only about 90 percent for domestic sales and about
40 percent for export sales. As a percentage of gross revenues (or the average wholesale
price) on sales to domestic refineries, the average tax take was 50-60 percent in 1993-1995,
90 percent in 1998, and 51 percent in 2000.
In aggregate, the oil extraction industry in Russia typically operated at a loss during the
1990s, mainly because of punishing taxation, and even in the few periods when it did not, the
government tax "take" was quite high and operating margins low. The tax take for the aver-
age producer through much of the 1990s even on flowing production amounted to over
100 percent of the operating margin, and the tax system renders virtually any type of project
requiring much capital investment completely uneconomic. The normal corporate profits tax
(reduced from 35 percent to 30 percent on March 1, 1999) scarcely applied to the oil sector,
since the burden of the other (revenue-based) taxes often left producers with no taxable
income. Thus, the industry found it extremely difficult to self-finance its investment needs.
Besides VAT and profits tax, which apply to all sectors of the economy, a number of spe-
cial taxes apply to crude oil production. The most important was traditionally the excise tax,
established in August 1992, the proceeds of which go to the Federal budget. Initially set at
18 percent of product sold by enterprises, it was later differentiated to (imperfectly) reflect
production costs. To simplify its administration, the excise tax was changed in April 1994
from a percentage ad valorem to an equivalent ruble per ton tax, but the actual rate was
adjusted quite frequently since then. Initially the tax was indexed to the ruble/dollar
exchange rate, but the indexation was subsequently removed (in 1997), so the value of the
tax plunged in real terms with the devaluation of the ruble in 1998. In 2000, reflecting the
fact that its value had become quite small, the variable character of the excise tax was elimi-
nated altogether in favor of a flat excise for all producers of 55 rubles per ton. Under the new
Tax Code, the excise tax on crude oil production is to be eliminated altogether.
Similarly, royalty payments for subsoil use were introduced in mid-1992. The royalty
rate varies between 6 percent and 16 percent of the value of product sold, and is determined
by negotiation, or through bidding in the case of new fields; the average is about 8 percent.
The proceeds go to Federal (40 percent), regional (30 percent), and local (30 percent) bud-
gets.
A geology fee (levy for regeneration of the mineral and raw material base) is applied as
well. Its proceeds are used to cover the exploration activities contracted by the Ministry of
Natural Resources, although a portion is returned to the oil companies for qualifying types of
exploration activity. These rates range from zero in the older oil-producing areas to 10 per-
cent for areas where state geological exploration is more substantial. This special levy for
funding geological exploration through the state budget has long been contentious, as it has
failed to effectively stimulate geological exploration and add to actual reserves. The elimina-
tion of the geology fee is incorporated in the natural resources section of Part 2 of the new
Tax Code (see below); it is to be phased out via a reduction of 2 percentage points per year
over five years.
In addition, the Federal Government, and especially regional and local governments,
have introduced a series of special-purpose levies that all enterprises must pay, including
those in the oil sector (e.g., road use tax, property tax, land use tax). Some are accounted for
in production cost (sebestoimost'), whereas most are paid out of profit.
Needless to say, the tax situation is one of the major factors underlying the overall
problems of the upstream oil industry. The combination of low (domestic) prices and high
taxes has left little or no room for producers to recover capital costs or even, in some cases,
operating costs, resulting in financial losses by oil producers and sharply curtailed investment.
Thus, tax reform is a major precondition for a continued recovery in the Russian oil sector by
providing sufficient incentive to carry out investment activity and the means to do so.
The government's plans to reform and simplify the Russian tax structure through the
new Tax Code have been repeatedly delayed since 1995, but this is finally being rectified.
Part 1 of the new Tax Code, establishing general rules governing tax payments and penalties,
and regulating relationships between taxpayers and tax agencies, went into effect on January
1, 1999. This was followed by the first section of Part 2 on January 1, 2001, which mainly
reformed Russia's complex social taxes (see below).
The plan advanced by Putin's government calls for passage of the remaining sections of
Part 2 of the new Tax Code by mid-2001 (including natural resource taxation), so that it goes
into effect on January 1, 2002. This part of the new Tax Code shifts the focus of oil taxation
from revenues and excises to profits. It also provides for a greatly simplified tax structure.
The new scheme for oil will include only three taxes: a relatively low royalty; a normal profit
tax (the same as applicable for all corporations in the economy); and an excess profit tax
designed to capture resource rents.23 The excess profit tax is specifically tied to project rates
of return. It is planned that the change in taxation would be phased in over a three-year
period during which companies will be able to choose when they will make the transition.
The goal of the reform is to create a self-regulating tax mechanism under which the state
does not require more money from oil companies than what they are capable of paying.
Another key element needed for effective tax reform is to ensure that the new Tax Code
is completely harmonized with PSA. A major achievement on this front occurred with the
passage of several tax laws in August 2000, essentially four chapters of Part 2 of new Tax
Code; these went into effect in January 2001. These laws—reducing selected VAT rates, sim-
plifying administration of social security taxes, and allowing more business expenses to be
deducted as costs—included explicit reference to PSA and its tax treatment. These new sec-
tions of the Tax Code not only confirm the existing exemptions from the general tax rules for
PSAs, but they also eliminated flaws in the previous tax laws they replaced. However, this
represents only the first step in legalizing the special tax treatment of PSA in Russian tax leg-
islation, and further harmonization is needed.
Another part of the planned tax reform remains the implementation of a special tax
regime for marginal wells. The goal is to lower taxes on so-called "low-flow wells" to where
they become profitable to produce. This could potentially affect as much as 30-40 percent of
current Russian production. The thrust to establish such a regime follows several previous
attempts, stemming from the inequities of the current tax regime. The main goal of these
measures is to provide sufficient incentives for producers to bring back on stream the large
number of idle wells in the sector.
One such attempt occurred in early 1999, under the Primakov government. The plan was
to exempt production from idle wells brought back on stream from the excise tax, royalties
(subsoil use fees), and the geology fee (payments for the rehabilitation of the mineral
resource base) through a special ordinance. In addition, the proposed ordinance would have
permitted owners of idle wells to lease them to service enterprises, which would then own
any oil that they subsequently produced.24 At that time, a Federal law also was under consid-
eration (Law on the Fiscal Regime of Assisting Oil Production), oriented toward the same
23
A more recent plan is to introduce a tax on mineral resources that replaces the excise tax, geology fee, and
royalty. The new tax is tied to an index calculated as a ratio between world oil prices and a set per-ton rate. This new
tax was approved in a first reading by the Duma in late June.
24
This would represent a shift back to the pre-1995 situation for oil service companies.
goal. This initiative essentially disappeared with the run-up in international prices after
March 1999. It remains unclear whether such a special regime needs to be established if the
tax system is properly calibrated to capture resource rents through the excess profits tax,
because the low profitability of such wells should ensure the appropriate tax treatment.
REGIONAL OIL PRODUCTION TRENDS
Nearly all of Russia's 33 or so oil-producing "regional subjects" of the Federation

(oblasts, republics, krays, etc.) reported growth in oil output in the 1999-2000 period, includ-
ing such key producers as Tyumen' Oblast, where almost two-thirds of Russian oil is pro-
duced. Output there rose 7.7 percent over the two-year period, to 213.0 mmt. Elsewhere, other
important producing regions also recorded growth during this period: the Komi Republic
(+6.3 percent, to 10.2 mmt); Tatarstan (+5.3 percent, to 27.2 mmt); Astrakhan' Oblast
(+72.3 percent, to 4.6 mmt); Nenets Okrug (+27.0 percent, to 2.3 mmt); and Sakhalin Oblast
(+100.5 percent to 3.4 mmt). The few areas reporting declines over the last two years included
Chechnya (-78.9 percent), Bashkortostan (-8.7 percent), Kaliningrad Oblast (-3.0 percent),
and the Udmurt republic (-3.0 percent).
West Siberia
West Siberia continues to be Russia's most important oil-producing province. During the
last 15 years or so, it has yielded some 68 to 73 percent of Russia's crude oil each year; in
2000, it supplied 68.0 percent. Thus, as pointed out above, developments in West Siberia
exert a dominant effect upon national production trends. Its major fields were the principal
problem area for Russia's deteriorating oil sector in the early 1990s (Sagers, 1994a), and they
are now a major factor in the turnaround in Russian oil production.
Crude oil production in West Siberia plunged by an incredible 211.7 mmt between 1988
and 1996, from its peak of 415.1 mmt to a nadir of 203.4 mmt (Table 3), a decline of
51 percent. The absolute decline in West Siberia alone represented almost 80 percent of the
overall decline in Russian crude oil production registered in 1988-1996. With the slide in
output, by 1996 West Siberia's share of the Russian total also dropped, to 67.5 percent. In
contrast, in 1988, the region had accounted for 73.0 percent of the Russian total.
Since 1996, West Siberian production has turned around. In 1997, regional output rose
by 1.7 percent, but then in 1998, with the Russian economic meltdown, dropped back again
before strongly rebounding in 1999-2000. In 1999, output increased modestly by 1.4 per-
cent, but in 2000 surged, rising by 6.3 percent, to 219.9 mmt (Table 3).
The prolific West Siberian Basin is the largest structural-sedimentary basin in the world,
encompassing over 3 million square kilometers. Favorable geological conditions also have
made it one of world's premier locations for the accumulation of hydrocarbons. The sedimen-
tary cover consists mainly of marine and continental deposits of the Jurassic, Cretaceous, and
Paleocene ages, overlain by more recent glacial, lake, and stream deposits (Clarke, 1994).
The oil- and gas-producing area of West Siberia lies physiographically in the West Sibe-
rian Plain, one of the world's largest and flattest plains. Consequently, it is very poorly
drained and prone to flooding. Most of the land consists of swamp or marsh. Broad areas are
inundated each spring when flood waters of the north-flowing Ob' and Irtysh rivers, or their
various tributaries, are jammed with ice that has not yet melted in the north.
Surface elevations in the West Siberian plain seldom exceed 100 meters above sea level
except along an east-west line of low glacial hills located about 250 kilometers north of the
middle reaches of the Ob' River. This line of hills divides the region, both physiographically
and in terms of hydrocarbon deposits. South of the low divide, rivers flow southward to the
Ob', whereas on the northern side, they flow northward to the Arctic Sea or the Ob' Gulf.
Most of the oil has been found south of the divide (in the region of the middle reaches of
the Ob'), whereas the region's natural gas is found to the north. The line of low hills also
approximates the boundary between two ethnic political subdivisions within Tyumen'
Oblast. The Khanty-Mansiysk Autonomous Okrug lies to the south, encompassing the major
fields along the middle reaches of the Ob' River (Middle Ob'), while the Yamal-Nenets
Autonomous Okrug lies to the north. The only other Russian oblast that has a significant por-
tion of its territory in the West Siberian Basin is Tomsk Oblast.
In 2000, 82.4 percent of West Siberian production came from Khanty-Mansiysk,
14.5 percent from Yamal-Nenets, 3.2 percent from Tomsk Oblast, and a negligible amount
from Novosibirsk Oblast. In 2001, some oil production also will come from Omsk Oblast, as
Sibneft' just brought on stream the Kravpivinskoye field (IPR, May 18-24, 2001), with
recoverable reserves estimated at 8.6 mmt. Sibneft' estimates that production at the field will
increase to 350,000 tons per annum by 2003, and that it may be producing 1 mmt per year in
Omsk Oblast in a few years time from several fields that it is developing.
A large number of companies produce oil in West Siberia, including most of the Russian
VICs. Several VICs, such as Surgutneftegaz, Slavneft', TNK, and Sibneft', produce all of
their oil in West Siberia. Collectively, the major Russian oil companies produced 204.9 mmt
in West Siberia in 2000, or 93.2 percent of the regional total. The largest regional producer is
LUKoil at 44.7 mmt (including only subsidiaries and not JVs), closely followed by YUKOS/
VNK at 41.6 mmt, and then Surgutneftegaz at 40.6 mmt.
Even more so than at the national level, in West Siberia a small number of large fields
traditionally accounted for the bulk of regional production. This concentration is typical of
most oil and gas basins, but what was unusual in West Siberia is that development in the late
Soviet period largely shifted only slowly from the larger fields to smaller ones as the basin
matured. The failure to extend the process of discovery and development to nearby, smaller
fields, so typical of Western practice, resulted in a huge stock of undeveloped smaller fields
at the beginning of the 1990s, which, by world standards, were still quite significant reser-
voirs (Wallin, 1992). Because of the overall size of the oil resource in West Siberia, Soviet
practice was to ignore the smaller fields and simply move on to the next giant. It has only
been in the last few years that the Russian oil industry has finally started to move on the
development backlog of these smaller fields, now that they have both the means and incen-
tives to do so.
One of the few larger projects in West Siberia that is moving forward is the development
of the Priobskoye field,25 although not with an international partner on the basis of a PSA as
originally envisioned. However, Priobskoye was added in 1999 to the list of fields eligible
for PSA (Table 8; IPR, November 19-25, 1999, p. 8), although a PSA has not yet been
signed. Oil production at the field is slowly ramping up, but it is being developed by the local
Russian company, YUKOS, on its own. The former Western partner, Amoco, spent over $70
million directly on the project, but after its merger with British Petroleum, the new company,
BP Amoco, decided to limit its exposure to Russian oil and officially withdrew from the
project in 1999 (SWB, March 19,1999).
The large Priobskoye field, located about 65 km east of the town of Khanty-Mansiysk in
the Ob' River floodplain, was discovered in 1982. Despite its location in the Middle Ob'
23
Priobskoye is billed as the Ob'-Irtysh area's single largest oil development project.
area, it was not fully developed because of the environmental and technical risks and prob-
lems posed by its site in the massive floodplain. The northern part of the Priobskoye field,
which straddles the river across the floodplain, was estimated by a reserve audit by interna-
tional petroleum engineers Miller and Lentz to contain at least 400 mmt of commercial
reserves in 1998. The field had been under development since 1988 by Yuganskneftegaz,
which subsequently became part of YUKOS when the latter was formed in 1993. Before
YUKOS was privatized in 1996, a total of about $200 million had been invested on the Ob's
left bank,26 infrastructure established, and around 500 wells had been drilled; in 1996, the
field produced about 0.8 mmt of oil.
Priobskoye was among the earliest fields to be offered in international tenders following
the passage of the Law on Underground Resources. The tender for the field was held in 1993,
with the rights to the northern part of the field won by U.S. oil major Amoco in a consortium
with Yuganskneftegaz (IPR, September 10-17, 1993, p. 9). Rights to the southern section of
the field, with reserves estimated at 80.9 mmt (Cj) and 136.6 mmt (C 2 ), were won by
Yugraneft', which is now owned 93.9 percent by Sibir Energy, a British-registered company
that clearly has Russian roots. An agreement between Amoco and Yuganskneftegaz on the
field's joint development was reached in 1994, envisioning a 50:50 split in financing, reve-
nues, responsibilities, etc. (SWB, September 30, 1994, p. 4). Development under the agree-
ment was expected to begin in 1996, although this was contingent upon several factors,
including passage of a suitable production-sharing law. In addition to the delays inherent
with this requirement, Amoco also found it difficult to negotiate with the new management
of YUKOS after the privatization of the company in 1996.
YUKOS has spent about $700 million on the field's development since 1996, and is cur-
rently spending about $200 million annually on the project (Frontier-Busting, 2001). The
field produced 1.3 mmt in 1999, 1.9 mmt in 2000, and YUKOS expects it to produce
3.2 mmt in 2001 (IPR, April 7-13, 2000, p. 12). In six to seven years, if all goes to plan, the
company expects the field to yield more than 15 mmt per year. Peak production is expected
to be perhaps 20 mmt per year. The project will require about $12 billion in total investment,
a substantial outlay, so YUKOS continues to seek a foreign partner.
YUKOS has attempted to move ahead on shifting the field to PSA. It has prepared a
draft agreement, conducted an environmental impact study, and prepared a feasibility study.
The package was submitted to the Khanty-Mansiysk authorities and the Ministry of Energy
some time ago. But progress has since bogged down in wrangling within the government as
to which ministry would deal with PSAs (see above).
Although no large PSA projects with international companies have actually been
launched thus far in West Siberia (although several remain in negotiation), the region had 17
JVs that reported oil production in 2000, considerably fewer than the 22 that produced in
1996. Collectively, the 17 JVs produced 11.8 mmt in 2000, or 61.8 percent of the total
amount of all JVs in Russia last year. However, the aggregate output of West Siberian JVs
has been declining since output achieved a level of 14.5 mmt in 1996. The aggregate decline
has been largely due to the demise of the service-type JVs, such as Yuganskfrakmaster, Rus-
sia's very first oil joint venture when it was established in 1989.
26
The left bank affords the easiest access to the northern part of the field (from the area of the Pravdinskneft'
producing unit), but Priobskoye's main reserves lie on the right bank. One of the major accomplishments in the
recent development of the field was the drilling of a horizontal tunnel under the Ob' River bed for two 426-mm
pipelines in 1998 to evacuate the oil via existing infrastructure.
Other Siberian Production
Sakhalin Island, in the Russian Far East, remains the only producer of commercial quan-
tities of oil in all of Siberia outside the prolific West Siberian Basin.27 Sakhalin has been a
relatively minor producer of oil historically, typically accounting for less than 0.5 percent of
total Russian oil output during the 1990s. Sakhalin's oil output had also been slowly falling
since the mid-1970s—oil output reached a peak of 2.6 mmt in 1985, but by 1994 had
decreased to 1.6 mmt. This trend has now been reversed, and in 2000, annual output almost
doubled, to 3.4 mmt, or to about 1.0 percent of national output (Table 3).
This was largely due to the launch of production by one of the offshore projects with
international companies, the Sakhalin-2 project.28 This project, one of only three operational
PSAs in Russia, became effective June 20, 1996 {PlanEcon Energy Report, Vol. 6, No. 2,
July 1996, p. 8), with the first oil being produced in July 1999. The project, which is sched-
uled to last 25 years, is billed as a $10 billion project. It envisions peak liquids production of
about 9 mmt per annum and peak gas production of about 15.5 bcm per year.
At present, oil production is only carried out during the ice-free navigation season,29
while drilling can be conducted year-round. This is because crude is exported directly by
tanker from the project's offshore Vityaz facility, comprising the Molikpaq oil platform, a
single-buoy mooring to load oil, a reservoir with a capacity of 1 million barrels, and the Okha
tanker. The stationary platform, from which 10 production wells have been drilled, is set up
in the Astokhskoye section of the Piltun-Astokskoyefieldabout 16 km offshore.
Sakhalin's climatic conditions have been a considerable obstacle, particularly the ice
hazard. Not only does the thick ice cover the surrounding sea for six months of the year, it is
also unstable, drifting at up to three meters per second. But that is not the only environmental
hazard—the area also is susceptible to earthquakes. Despite these numerous challenges,
Sakhalin Energy Investment Company produced 143,500 tons of oil in 1999 and 1,672,080
tons in 2000.30
The other major recent change involves a change in ownership for Sakhalin-2, with
Royal/Dutch Shell taking over U.S.-based Marathon Oil's 37.5 percent stake in mid-2000
(Fallon, 2000b), raising its own stake in the oil and gas exploration project to 62.5 percent to
supplant Marathon as the lead operator.31 The project's other shareholders are Japan's Mitsui
(25 percent) and the Mitsubishi Corporation (12.5 percent).
27
Only negligible amounts of oil are produced in the Evenk Autonomous Okrug, Taymyr Okrug, and Irkutsk
Oblast (in East Siberia), and in the Sakha republic (Yakutia) in the Far East region.
28
The Sakhalin-2 project encompasses two fields located about 15 kilometers off the island's northeastern
coast: Piltun-Astokhskoye and Lunskoye. Combined, reserves at the Piltun-Astokhskoye and Lunskoye fields total
140 million tons of oil (concentrated mostly in Piltun-Astokhskoye) and 408 billion cubic meters of gas (mostly
found in Lunskoye). In June 1994, it became Russia's first project to be signed under the terms of a PSA (Sagers,
1995).
29
Sakhalin-2 just began its third season of commercial production at the end of May 2001 (IPR, June 1-7,
2001).
30
SakhaIin Energy Investment Company is the name of the Sakhalin-2 international consortium of companies
(originally Marathon, Mitsui, Mitsubishi, McDermott, and Shell) incorporated into a single operating company in
Russia.
3l
In exchange for relinquishing its Sakhalin-2 stake, Marathon (headquartered in Findlay, Ohio) will acquire
all of Shell UK Ltd.'s interests (28 percent) in the BP Amoco-operated Foinaven field and associated infrastructure,
located in the Atlantic margin west of the Shetland Islands in the United Kingdom, and a 3.9 percent overriding roy-
alty on 100 percent of the production from eight blocks in the Gulf of Mexico, including the Ursa field. The trans-
action's estimated value was $300-400 million.
Marathon's decision was largely the result of a change of focus within the company.
Sakhalin-2 once was one of Marathon's key elements in its strategy for the future, but further
development would require large amounts of investment. Marathon's current goal is to
improve financial flexibility by enhancing cash flow in the near- to mid-term. The properties
it received have a high, near-term payout, whereas Sakhalin, on the other hand, is a very
long-term play.
Contrary to what some analysts have cited as yet another blow to the investment climate
of Russia, Marathon's pullout from Sakhalin-2 should be viewed in a more positive light.
Originally, Marathon was awarded the Sakhalin-2 project because of high political risk in the
USSR/Russia in 1991-1992, which frightened away larger, more risk-averse bidders.
Sakhalin-2 is a rather atypical project for a small oil company with relatively limited interna-
tional experience. Initially, Marathon had set out to develop an offshore oil field, but later it
turned out that the fields actually contained more gas, substantially boosting the difficulty
and costs of the project. This has remained Marathon's only foray into Russia (and the entire
CIS for that matter), although it investigated other projects and once harbored ambitions to
expand its presence in the region.
Shell is more suited for operating such a large, complicated project, as it has the
resources,financialand managerial, as well as the particular technical expertise necessary for
the next phase of development, which includes extracting and marketing the gas in a lique-
fied form (LNG). It has been estimated that the entire Sakhaiin-2 project will involve $10 bil-
lion of investment, so Shell's acquisition represents a $6 billion vote of confidence in the
project. Marathon's departure does not reflect poorly on Russia's investment climate, but
rather Shell's further involvement can be seen as a vote of confidence in the project and for
PSA in Russia.
Thus far, Sakhalin Energy has invested about $1.5 billion, including a $348 million loan
issued by EBRD, OPIC, and the Export-Import Bank of Japan. Future development plans for
the Piltun-Astokhskoye field include the construction of two more platforms and a larger off-
shore loading facility. For the next few years, Sakhalin Energy plans to continue to load oil
offshore directly to tankers. But in 2004, a pipeline is planned to be built from the areas of
production southward to the southern part of Sakhalin Island, to a new oil terminal in ice-free
Aniva Bay at Prigorodnoye.
Thus, Sakhalin Energy has decided to develop a southern route for the marketing of its
oil and gas production, involving the construction of separate oil and gas pipelines running
onshore on Sakhalin Island to Prigorodnoye, near Kosakov. At Prigorodnoye, a new marine
terminal to handle oil exports is planned as well as a liquefaction plant for liquefied natural
gas (LNG) exports. The LNG facility will have a capacity of 9.6 million tons per year. After
some deliberation, this was selected as the most sensible option for marketing the project's
gas. The major alternative was a sub-sea pipeline to Japan, but this option was not chosen
due to both high costs and much reduced flexibility in gas marketing. Sakhalin Energy plans
to produce itsfirstcommercial gasfromthe Lunskoyefieldin 2006.
Sakhalin Island's other operating PSA, the Sakhalin-1 project, which is led by Exxon-
Mobil in a consortium with Japan's Sodeco, Rosneft',32 and now India's ONGC (see below),
is not expected to begin commercial oil production until 2005-2006 (IPR, February 16-22,
2001). A production-sharing agreement was signed on the project, covering the development
32
Rosneft' subsidiaries Rosneft'-Sakhalin and Sakhalinmorneftegaz initially received stakes of 17 percent and
23 percent in the project, while ExxonMobil and Sodeco held 30 percent each {IPR, June 30-July 7, 1995, p. 11).
The actual operator is Exxon Neftegaz Ltd., an ExxonMobil subsidiary.
of the Chayvo, Arkutun-Dagi, and Odoptu fields, in 1995 (Sagers, 1996). This production-
sharing agreement was also "grandfathered" under the Law on Production Sharing, and also
declared to be "implemented" in June 1996. Arkutun-Dagi is the largest known field on the
Sakhalin shelf. Discovered in 1989, it is estimated to contain 113 mmt of oil, 5 mmt of con-
densate, and 68 bcm of gas. Together, the three fields contain an estimated 291 mmt of oil
and 421 bcm of natural gas.
The project, which will last 33 years, calls for production to reach a peak of 10 mmt of
oil and 15 bcm of gas annually about four years from initial production. However, initial pro-
duction will follow a five-year "evaluation" period. During this period, the consortium is
expected to spend about $250 million, i.e., about $50 million per year. In 2000, $50 million
was spent, mainly on drilling the Chayvo-6 well (SWB, November 10, 2000, p. 8; IPR,
November 10-16, 2000). In 2001, Sakhalin-1's budget is $145 million.
Development plans for the project include three platforms (two at Chayvo and one at
Arkutun-Dagi), located about 16 km offshore. From them, nearly 800 wells are to be drilled,
most using slant drilling. Extraction of oil at Odoptu is planned to be accomplished without
an offshore platform, using only slant-drilled wells from onshore (IPR, October 6-12, 2000).
An oil pipeline (530 mm) and a gas pipeline (1,000 mm) are to be built to reach onshore
facilities located near Katangli.
Sakhalin-1 's development program envisions that the first stage will focus on the devel-
opment of the Chayvo and Arkutun-Dagi fields, with development of Odoptu to come later.
This first stage of development is estimated to cost $12.7 billion (IPR, June 30-July 7,1995,
p. 11), while the total project is billed as requiring about $15 billion in investment.
Initially, an export terminal was planned near Korsakov in southern Sakhalin for crude
oil as well as a gas liquefaction plant (for LNG) for the Sakhalin-1 project, virtually duplicat-
ing the infrastructure contemplated for the Sakhalin-2 project (Sagers, 1995). However, a
decision has been made to pursue a western export route via the Russian mainland for both
oil and gas (Two Routes, 2001, p. 24). This occurred despite considerable pressure from the
regional administration to create a unified transport infrastructure, not only to reduce costs,
but also to keep the infrastructure wholly within Sakhalin Oblast.
ExxonMobil has given preference to the western route for several reasons. One is that oil
and gas pipelines already exist along this route. An oil pipeline runs to the Komsomol'sk
refinery on the Russian mainland and to a new export facility at DeKastri, on Chikhachev
Bay,33 while the gas pipeline extends to Komsomol'sk. For Sakhalin-1 to use them, only
33
The facility at DeKastri is Russia's first new crude export terminal to open since the transition period began;
it went into operation in May 1998 (Two New, 1999). It is located on Khabarovsk Kray's coast, fronting on the Tatar
Strait opposite Sakhalin Island. The DeKastri terminal was built by Sakhalinmorneftegaz to allow it to more easily
export its high-quality crude directly to Asian/Pacific markets. The new terminal lies along the crude pipeline
between Sakhalin and the Komsomol'sk refinery. It employs a 100,000 ton storage facility, and uses a flexible hose
system to connect the pipeline and the tankers moored at the terminal. In addition to its other advantages, the new
facility has also reduced seaborne shipping costs (by about $1 per ton) because of shorter hauls to reach destination
markets than possible from Moskal'vo, located on the northern end of Sakhalin island. Since it is located farther
south, it can operate for nine months each year instead of just the four months per year that Moskal'vo is ice-free.
Also, DeKastri has an 18-meter-deep channel that allows it to handle tankers up to 50,000 DWT, whereas
Moskal'vo's terminal had to use shuttle tankers to load larger ships moored in deeper water offshore. In 1998, the
new DeKastri terminal handled about 700,000 tons of crude, or about half of Sakhalinmorneftegaz's production. In
2000, about 1.5 mmt was exported via DeKastri. The DeKastri facility could be expanded to a capacity of 5 mmt, or
even 10 mmt per year, and the port could handle tankers up to 60,000-80,000 DWT with further dredging. The larger
size would also allow the facility to operate year round.
partial modernization and reconstruction is needed, along with connector lines (IPR, Novem-
ber 24-30,2000).
For gas exports, ExxonMobil has a preference for pipelines over LNG. The consortium
is therefore planning to construct an overland gas pipeline to northern China; some gas prob-
ably also will be sold to Russian consumers on the Russian mainland (Petroleum Economist,
November 2000, pp. 10-15). The consortium also is still considering building a gas pipeline
to Japan as well. ExxonMobil is working through a consortium to develop a feasibility study
for such a pipeline (Petroleum Economist, June 1999, p. 107; IPR, 1999, p. 12).
A change in membership for the Sakhalin-1 consortium also has taken place recently. On
February 10, 2001, after a year of talks heavily supported by the Russian and Indian govern-
ments, Russia's state-owned oil major, Rosneft', finalized a deal to sell half of its 40 percent
stake in the Sakhalin-1 project to India's national oil company, the Oil and Natural Gas Cor-
poration (ONGC) (Fallon, 2001). Rosneft's subsidiaries transferred half of their shares—
8.5 percent from Rosneft-Sakhalin and 11.5 percent from Sakhalinmorneftegaz—to ONGC's
international arm, ONGC-Videsh Ltd. (OVL), for a reported $315 million. This represents
part of ONGC's recent international drive to increase its production (until now entirely from
domestic sources) from 30 percent of Indian demand to 50 percent over the next 10 years.
Rosneft's foreign partners in the Sakhalin-1 consortium, ExxonMobil and Sodeco, waived
their preferential option to purchase the 20 percent stake, which allowed the deal with OVL
to go through.
Basically, the deal was that ONGC would be able to purchase a stake in Sakhalin-1 in
return for an order by the Indian government for Russian armaments. The deal arose after
Russian President Vladimir Putin visited the subcontinent in October 2000. Initially, the
well-traveled President's visit to New Delhi did not appear to bring any significant results. In
response, the Russian government reduced the value of military hardware it had planned to
sell to India. The Indians offered very attractive terms for the 20 percent stake in the Sakha-
lin-1 project, and in turn, received a rebate on the military hardware purchase.
Besides the cash, OVL's $2 billion investment commitment also assumes Rosneft's
share of the total cost of the estimated $10 billion project. Of the $315 million payment, Ros-
neft received $90 million as reimbursement for its previous exploration expenses and $225
million as a premium for the stake. Participants in Sakhalin-1 are due to invest $4 billion into
this project before commercial production begins in 2005-2006. With this deal, Rosneft' is
relieved of the burden of financing its share of the investments in Sakhalin-1, will get the
financing it needs for other activities, and ONGC will get its biggest foreign oil project.
Volga-Urals Basin
The Volga-Urals Basin encompasses an area of approximately 500,000 km2 that extends
from the western flank of the Ural Mountains across the drainage basin of the Volga River.
Like the other producing areas in the European part of Russia (as opposed to Siberia), most
hydrocarbon extraction has been from Paleozoic strata; in the Volga-Urals region, this has
been almost exclusively Devonian and Carboniferous rocks.
The Volga-Urals oil-producing region includes at least part of the territories of 10 differ-
ent oblast-level subdivisions and a similar number of major oil-production entities that are
now grouped within the various VICs. The Volga-Urals fields now represent Russia's
second-largest producing region, but it was the leading oil producer until being surpassed by
West Siberia in 1978. However, regional output has been falling for over 25 years (output
peaked in 1975 at 226.3 mmt), as development is in a post-mature phase. Production in the
region began in the 1930s, but did not really accelerate until the 1950s, with the development
of the supergiant Romashkino and Arlan fields and several others.
In 2000, output was down to 83.4 mmt for the entire region (Table 3, entries for Volga
plus Urals regions), representing 25.8 percent of the Russian total, compared with 55.0 per-
cent in 1975 at peak production and 21.9 percent in 1990 on the eve of the transition period.
Output from nearly all the major producing areas within the Volga-Urals has been generally
declining during the last two decades, with a few minor exceptions (e.g., Astrakhan' Oblast).
All of the region's major fields have been worked for 30-40 years (or more), with most of the
reserves having been pumped. Current efforts at deeper drilling and expanded use of second-
ary and enhanced recovery techniques have slowed the decline, but production has still been
slowly drifting downward, although some areas have actually seen a limited upturn in the last
year or two (e.g., Tatarstan, Orenburg Oblast, Volgograd Oblast). But this is probably a
transitory phenomenon reflecting the particular circumstances of the moment, rather than a
reversal of the long-term trend.
The major Volga-Urals fields (e.g., Arlan, Tyumazy, Shkapovo, Mukhanovo, Belebey,
and Yarino) are well past their peak levels of output, with remaining reserves found increas-
ingly in smaller, more dispersed fields in the "hard-to-recover" category. The Volga-Urals
fields, with a much smaller number of wells, have yielded far more oil per square mile of
area than the basins of the United States (e.g., see Dienes, 1993, p. 107).
The largest producing area in the Volga-Urals region is the autonomous republic of
Tatarstan, home of the Tatar oil-production administration (Tatneff). Oil production peaked
in the republic in 1975 at 104.6 mmt, and reached a nadir of 24.2 mmt in 1994; by 2000, out-
put had recovered to 27.2 mmt (Table 3). Tatneft' itself accounts for the bulk of the republic's
output, producing 24.3 mmt in 2000. Small oil companies produced a combined 3.4 mmt in
1999 and about 2.9 mmt in 2000 (IPR, March 3-9,2000, p. 13).
The principal field in Tatarstan is the "supergiant" Romashkino field at Al'met'yevsk;
even after producing about 2 billion tons of oil since its first commercial production in 1952,
it still accounts for about 60 percent of Tatneft's oil production (Hopes Rise, 2000, p. 19).
This field was one of the first in Russia approved for PSA status (Table 8), but progress on
finalizing a PSA has been agonizingly slow. Other important fields are Bavly (where oil was
first struck in the republic) and Novo-Yelkhovo/Aktash, both of which were rated as
"giants." Romashkino is considered the second-largest oil field in Russia, with Western esti-
mates of ultimate recovery reaching as high as 3.3 billion tons, about equal to levels assumed
for Samotlor. The field is confined to the South Tatar Dome, which localized and trapped the
oil; it covers a massive area of approximately 2,500 square miles. Discovered in 1942 and
actively developed since 1948, Romashkino commenced commercial production in 1952,
almost a decade after discovery.
Bashkortostan, another (autonomous) republic, is the second-largest producing area in
the Volga-Urals region. Bashkortostan's oil output peaked in 1967 at over 40 mmt, and has
been steadily declining since. By 2000, its output was down to only 11.7 mmt (Table 3). The
republic-owned oil company, Bashneft', is responsible for the bulk of this production. Bash-
neft', which also produces small amounts of oil outside Bashkortostan (in the Udmurt and
Tatar republics as well as in West Siberia), produced 11.9 mmt in 2000. The main Bashkir
fields are Arlan, Belebey, Tuymazy, and Shkapovo. The largest is the "supergiant" Arlan
field at Neftekamsk in the northern part of the republic.
Traditionally, the third-largest producing unit in the Volga-Urals region was Samara
Oblast, but it was edged out of this position by Perm' Oblast in 1995; it was then surpassed
by Orenburg Oblast in 1997, relegating Samara Oblast to only fifth position within the
Volga-Urals region. Samara Oblast yielded 8.1 mmt in 2000, while Perm' Oblast's output
was 9.4 mmt, and Orenburg Oblast produced 9.1 mmt. Samara Oblast is home to the Sama-
raneftegaz production association (formerly known as KuybyshevnefV), which was incorpo-
rated into the YUKOS oil company in 1995, while Perm' Oblast contains Permneft', now a
LUKoil subsidiary. Orenburg Oblast's main producer is Orenburgneft', a subsidiary of
ONAKO.
Oil production in Samara Oblast began with the exploitation of the Syzran' field in
1936; output in the oblast peaked in 1971-1972 at 35.6 mmt. Most of the fields in the oblast
are fairly small, but there are a few larger fields. The principal fields are the "giant" Mukha-
novo and the smaller Kuleshovka and Sergiyevsk fields. The Mukhanovo field, located at
Otradnyy, began production in 1955; by the late 1960s, it accounted for 40-50 percent of the
oblast's output. The Kuleshovka field, located at Neftegorsk, came on stream in the late
1950s, and the Sergiyevsk field, located at Orlyanka, was developed in the mid-1960s. Sev-
eral smaller fields brought into production in the late Soviet period were located farther
southwest, in the Buzuluk Depression.
In Perm' Oblast, oil output peaked in the mid-1970s at 22 mmt, but then dropped precip-
itously to 14.9 mmt by 1980. Since then, the rate of decline has tapered off and output has
remained fairly stable at about 9.2-9.4 mmt since 1994.
Orenburg Oblast's oil production is now on a par with both Perm' and Samara, as their
production has contracted in the last two decades while that in Orenburg has held relatively
steady. And, like those regions, its output also has increased over the past year or two; Oren-
burg Oblast's output was 9.1 mmt in 2000 (Table 3). Oil is produced in Orenburg Oblast by
two main operators—Orenburgneft', the key component of the Orenburg Oil Company
(ONAKO), and the Gazprom subsidiary Orenburggazprom, which produces gas condensate
from the Orenburg gas field. Orenburggazprom produced 2-3 mmt in the 1980s, while its
output now is only around 0.4-0.5 mmt.
Other producing areas of the Volga-Urals Basin include the Udmurt republic, Saratov
Oblast, and the area of the lower Volga that includes Volgograd and Astrakhan' oblasts. A
small amount of oil has been produced in Ul'yanovsk Oblast since 1980; in that year 15,000
tons were produced, which increased to 135,000 tons by the mid-1990s (Goskomstat Rossii,
1995 p. 247), and is now running at 0.3-0.4 mmt per year (Table 3).
Udmurtneft' and Saratovneftegaz are the production associations working the fields of
the Udmurt republic and Saratov Oblast; they are both Sidanko subsidiaries. Production in
the Udmurt republic peaked in 1985 at 12.0 mmt, and then has slowly declined, to 7.7 mmt in
1999-2000 (Table 3). Production by Udmurtneft' itself mirrors this trend, with output declin-
ing to 5.2 mmt by 2000.
Oil output in Saratov Oblast is based on several small fields on the opposite bank of the
Volga River from the city of Saratov. Output was never large, and peaked before 1960 at
about 3 mmt. By 2000, output in the oblast was at 1.4 mmt (Table 3).
Traditionally, the entire area of the lower Volga was the province of the Nizhnevolzhsk-
neft' enterprise, but in the early 1990s, it was broken up into three parts—Nizhnevolzhsk-
neft' proper (i.e., Volgograd Oblast) and Astrakhanneft' (its former field directorate in
Astrakhan' Oblast), both of which joined LUKoil, while production in the Kalmyk republic
was organized into Kalmneft'. The break-up occurred at the insistence of the Kalmyk Presi-
dent, Kirsan Ilyumzhinov, that the Kalmyk republic's "sovereignty" over its resources be
respected (IPR, October 29-November 5, 1993, p. 8).
The principal producing area in the lower Volga has long been Volgograd Oblast. Output
in Volgograd Oblast actually has been significantly higher in the late 1990s (3.6-3.9 mmt)
than at any time in the last two decades (Table 3), although this is still far less than the
6.6 mmt produced at the peak in 1970. The main source of crude oil is the Zhirnovsk field, in
the northern part of the oblast, but other producers include the Archeda field at Frolovo and
the Korobi field at Kotovo. The production in Volgograd Oblast is from reservoirs associated
with a southwest finger-like extension of the Volga-Urals Basin, while oil production in the
Kalmyk republic is from reservoirs associated with the North Caucasus structural trough.
In Astrakhan' Oblast, the rather small output of Astrakhanneft' (72,700 tons in 2000), is
overshadowed by the gas condensate produced by the Gazprom subsidiary of Astrakhangaz-
prom. The condensate is from the high-sulfur Astrakhan' gas field, structurally part of the
North Caspian Basin. The production of Astrakhanneft' is from only one field, Beshkul',
although the enterprise has licenses to three fields {IPR, July 5-12, 1996, p. 10).
The Volga-Urals fields have attracted some JV activity, with as many as 14 joint ven-
tures producing oil in the region during the last decade. However, with a collective output of
only 2.5 mmt in 2000, they account for only about 13.1 percent of total JV production in
Russia.
The largest of these joint ventures is now Volgademinoil, boasting an output of 452,700
tons in 2000. Volgademinoil is a JV established between Nizhnevolzhskneft' and Germany's
Deminex Volga Petroleum GmbH (which subsequently ceded a 5 percent stake to another
German company, Preussag AG) to explore and develop fields in Volgograd Oblast. Its
license is to a 22,650 km2 contract zone. It sunk the first of its three planned exploration
wells in 1995, and produced its first oil in mid-1996 (IPR, October 4-11, 1996, p. 10).
A major change may be in store for the entire Lower Volga region with the evident dis-
covery of an entirely new producing province for Russia in the offshore Caspian Sea. Rus-
sia's largest oil company, LUKoil, announced on March 23, 2000 that it had confirmed the
existence of a major oil field in what it described as the Russian section of the Caspian Sea
(Fallon, 2000a). The find, known as Khvalynskoye field, is located -350 km south of Astra-
khan' in the so-called Severnyy block (Northern license area).34 This marks the first signifi-
cant discovery in the offshore area of the northern Caspian Sea; the international consortium
(OKIOC) drilling in the neighboring Kazakh sector of the shelf (on the Kashagan structure)
completed its first exploratory well about the same time.
LUKoil's exploration well confirming the presence of commercial quantities of hydro-
carbons was drilled to a depth of 4,200 meters, and encountered seven producing horizons.
LUKoil announced that the new offshore field contains 300 million metric tons (2.2 billion
barrels) of recoverable oil reserves. The quality of the crude is reportedly similar to Azeri
Light in terms of density and sulfur content. LUKoil claims to have effectively opened an
entirely new producing province for Russia. However, the overall size of the reserves
reported by LUKoil must be viewed with some caution, as this amount was LUKoil's expec-
tation of the reserve base before drilling actually started, and it may reflect the traditional
Soviet-type assessments of technical reserves; measurement of the oil field's size according
to Western standards (based on commercial considerations) might yield rather different
results. The field also may contain large volumes of natural gas.
LUKoil began drilling on the Severnyy block on June 19, 1999 using the Astra jack-up
rig, which can operate in water up to 100 meters deep. Wells down to 5,000 meters, however,
can only be drilled in shallower water (45 meters). Drilling of the first exploratory well fol-
lowed seismic surveys over a 60,000 km2 area. This initial effort identified six promising
34
LUKoil acquired the rights to the Severnyy block (8,054 km2) in December 1997, following a bitterly con-
tested tender with YUKOS.
structures—three in deep water and three in shallow water. Two of these structures, identified
as Khvalynskoye and Druzhba, were selected as the initial drilling targets.
The Astra jack-up is the first Russian drilling rig on the Caspian. Its deployment illus-
trates one of the key constraints to offshore development in the Caspian—the lack of drilling
equipment. LUKoil acquired it from Norway's Stavanger Drilling for $15.5 million in early
1997 and it was moved from the Persian Gulf under a contract with Finland's Aker Rauma
Offshore.35 It was dismantled and cut into sections at a Finnish shipyard before being trans-
ported through Russia's system of internal waterways (including the Volga River) and deliv-
ered to the Krasnyye Barikady (Red Barricades) shipyard in Astrakhan'. At Astrakhan', the
rig was reassembled and modernized, allowing its potential drilling depth to be increased
from 3,500 meters to 5,000 meters. The entire project to acquire, transport, and prepare the
rig cost about $75 million.
LUKoil has spent about $200 million on the project so far. The project calls for a total of
eight exploration wells to be drilled, along with 200 producing wells. LUKoil plans to drill
two more exploration wells at the site this year. Drilling of production wells will not begin
until the fourth year of the project, with oil production slated to start in the fifth year. Peak
production is expected to be reached in the eighth year (ca. 2008) at 15-20 mmt per year.
LUKoil plans to invest $6 billion in developing the field over the next 10 years.
LUKoil's unorthodox approach to the project was to launch offshore exploration and
drilling on its own, and then to draw foreign investors into the project after discovering
hydrocarbons. Taking on the risky exploration phase of a large offshore oil project by itself
without first attracting foreign investment commitments was viewed as foolhardy, but was
probably the only way for LUKoil to proceed given the situation in Russia. LUKoil has
already begun to lobby the government to submit to the State Duma amendments to the Law
on Production Sharing, with the aim of making it easier to attract foreign investors to its Cas-
pian project. At a ceremony in Astrakhan' attending the announcement of the discovery,
Deputy Prime Minister Viktor Khristenko said that in principle the government is ready to
support production-sharing agreements for major projects involving promising structures
with inherently high risks (like Khvalynskoye).
The Russian jubilation at this find (front-page news in most Russian newspapers), the
largest in 20 years, may be tempered by the debatable point of whether it is actually located
in the Russian sector of the Caspian. The Kazakhs protested when the tender was announced
back in 1997, and as pointed out by Kazakhstan's Deputy Industry Minister Nurlan Kappa-
rov, who heads the Kazakh delegation at talks with Russia on determination of the offshore
boundary, the discovery may actually lie on the Kazakh side of the median line.
Under a Russian-Kazakh agreement, signed on July 6, 1998 (Carving, 1998), the seabed
of the northern portion of the Caspian Sea (the area adjoining Russia and Kazakhstan) was
divided into national sectors. Under this accord, the median line principle was agreed to, but
the boundary has not yet been delineated. If the oilfield straddles the boundary line, then the
field would have to be developed jointly according to Kapparov.
Timan-Pechora Basin
The Timan-Pechora Basin, located in northern European Russia astride the Komi
Republic and the Nenets Autonomous Okrug, is a significant hydrocarbon-producing region.
In recent years, it has accounted for 3-4 percent of the oil produced in the Russian Federation
35
The rig was built by the Japanese in 1983, and had been operating in the Persian Gulf as the Marava.
(Table 3). The Basin is one of several hydrocarbon-producing syneclises of the Uralian-Mon-
golian mobile belt, lying along the downwarped foredeep of the western slope of the Ural
Mountains. This large sedimentary structure, filled with mainly Paleozoic and Mesozoic sed-
imentary rocks, extends over an area of approximately 320,000 km2 onshore, while its off-
shore extension, into the Barents Sea, may represent a prospective area of another
800,000 km2 (Sagers, 1994c). Most of the basin's hydrocarbon production is from lower
Paleozoic beds (especially Devonian reservoirs).
This large sedimentary basin is located north of 60° N. Lat., with the most productive
portions of the basin located north of the Arctic Circle. The bulk of the basin is therefore
comprised of a swampy lowland covered by taiga, although the portions fronting on the
Pechora Sea are covered by tundra; much of the area is underlain by permafrost. Because of
its location, hydrocarbon exploration and development activities must be conducted in a very
harsh environment under extreme temperatures.
Partly because of the harsh conditions,36 the region's development received a lower pri-
ority than the Volga-Urals, and later West Siberia. Thus, the area is now among the most
promising in Russia in terms of its potential for growth in hydrocarbon production, espe-
cially of oil. This reflects the fact that the basin contains many already discovered, but unde-
veloped oil fields. Only about 10 percent of the initial oil endowment has already been
extracted. A total of 190 oil and gas fields have been discovered in the basin (IPR, April 2 8 -
May 4, 2000, p. 12), while only 32 are currently being worked (18 by Komineft'); only two
of these are in the Nenets Okrug (see below).
Geographically, most of the Timan-Pechora Basin lies within the Komi Republic, but it
also extends across an internal border into the Nenets Autonomous Okrug of Arkhangelsk
Oblast. While most current production is from fields that lie within the Komi Republic, most
of the large fields being prepared for development are located in the Nenets Okrug.
Officially, the "commercial" or "proven" (A + B + C,) reserves of oil in the basin
amount to 1.35 billion tons, with another 0.54 billion tons of "prospective" (C2) reserves.
Most (59 percent) of the basin's remaining "commercial" reserves are located in the Nenets
Okrug's 65 discovered fields. A large percentage (42 percent) of the A + B + C, reserves in
the Nenets Okrug is found in just four fields—Khar'yaga, Toravey, South Khylchuyu, and
Naul. In the Komi Republic, the bulk of A + B + C, reserves (68 percent) are concentrated in
just seven of the currently producing fields.
The Timan-Pechora Basin's considerable hydrocarbon potential is not lost on foreign
investors. It already hosts several producing joint ventures and one implemented production-
sharing agreement. The oil resources of the Timan-Pechora Basin also figure prominently in
several other "mega-projects" with Western companies that currently are under negotiation.
Total petroleum production (including condensate) in the region peaked in 1983, at over
20 mmt; production had risen sharply during the 1970s from 7.6 mmt in 1970 to 20.4 mmt in
1980. After 1983, however, petroleum output fell significantly, slowly drifting down over the
course of the 1980s, to 15.8 mmt in 1990, and then began to fall more rapidly, reflecting the
larger overall production crisis in the Russian oil sector. By 1995, oil production in the region
as a whole had fallen to only 9.6 mmt (Table 3), less than half of the peak level of 1980; by
2000, however, output had recovered to 12.5 mmt.
In the early development phase of the oil resources of the Timan-Pechora Basin, extend-
ing from the 1930s through the 1950s, several small fields in the area south of the Pechora
36
Another factor slowing development was the heavy, paraffinic character typical of the oils in the region.
and Usa rivers (near the city of Ukhta) were brought into production. These included the
Chib'yu field, which began to be produced in the 1930s, as well as the unusually heavy, vis-
cous crudes of the Yarega deposit (which is produced by mining methods). But the principal
producer was the West Tebek field, about 65 km east of Ukhta, which was brought on stream
in 1962, giving rise to the town of Nizhniy Odes. Two other sizable fields subsequently also
were developed in this area—Dzh'yer (in 1967) and Pashnya (in 1970).
Then, in the early 1960s, exploration was extended to the area to the north, into the area
near the Arctic Circle about 300 km northeast of Ukhta. Two major fields, both rated as
"giants," were discovered and brought into production—Usinsk and Vozey37; these discov-
eries were followed by the subsequent discovery of the Upper Grubeshor field, located north-
west of Vozey. The development of Usinsk and Vozey sent the Komi Republic's oil
production climbing during the 1970s and decisively shifted the oil industry's center of grav-
ity away from the area around Ukhta where it had been before. Usinsk and Vozey remain the
two largest producing fields in the basin, with Usinsk evidently being the more prolific of the
two. These two fields accounted for more than 60 percent of Komi oil production by the
early 1980s, and by the early 1990s, the Usinsk area was producing 80 percent of Timan-
Pechora oil (IPR, April 1-8, 1994, p. 28). Usinsk alone accounted for 44 percent of regional
production in 1991, and Vozey for 31 percent.
The focus of oil development continued to shift northward, to the Khar'yaga field,
located just across the border of the Komi Republic in the Nenets Autonomous Okrug.
Khar'yaga yielded its first commercial oil late in 1987 (Sotsialisticheskaya industriya, Octo-
ber 14, 1987, p. 1). Similar to other fields in the region, Khar'yaga produces a paraffinic oil
that requires special extraction methods, including steam and gas injection and mixing with
reagents. Oil from the Khar'yaga field is shipped south via an 80 km pipeline to Vozey,
where it connects with the existing Vozey-Usinsk pipeline and then the Usinsk-Ukhta-
Yaroslavl' trunk pipeline operated by Transneft'. Construction on the feeder pipeline com-
menced in 1986, and the line became operational in 1989. The Vozey-Usinsk connector was
involved in the much-publicized oil spill in the fall of 1994 (Sagers, 1994b). A World Bank
loan for rehabilitation and clean-up was extended subsequently to Komineft'.
Most of the oil produced in the Timan-Pechora Basin was traditionally extracted by
Komineft'. But the company's share of production has been declining over time as a result of
the proliferating number of new entrants. In 1990, the share of Komineft' amounted to
96 percent, but its share subsequently has fallen to 31.6 percent in 2000. Among the new
entrants are the 10 operating JVs in the Timan-Pechora Basin, which in 2000 produced
6.0 mmt, slightly less than their output in 1998 (6.4 mmt). One of these, Conoco's "Polar
Lights," ranks among the largest field-development joint ventures in Russia. The joint ven-
ture, formed with Arkhangelskgeoldobycha, was officially registered in 1992, although work
on the creation of the venture started in 1990. The JV was formed to develop several fields,
collectively known as the Ardala complex, located in Arkhangelsk Oblast's Nenets Autono-
mous Okrug near the Arctic Circle. The complex of fields operated by Polar Lights, compris-
ing Ardala (Ardalinskoye/Ardalin), East Kolva, Dyushevskoye, and Oshkotynskoye, is
estimated to contain about 15 mmt of recoverable oil reserves—12.2 mmt at Ardala, 2.5 mmt
at Dyushevskoye, and 1.3 mmt at East Kolva.
Conoco's initial development plan called for drilling 24 wells at Ardala and the con-
struction of a central oil treatment facility, but only 15 wells had to be drilled to reach
37
Usinsk was discovered in 1963, with commercial production beginning in 1973; Vozey was discovered in
1972 with commercial production ensuing in 1975.
planned production levels. Thus far, the major focus of development has been Ardala itself,
with little activity at the other outlying fields. Drilling of the first well began at Ardala in
September 1993, and Polar Lights produced its first oil in August 1994. In 1994, the joint
venture produced 346,400 tons of oil, and in 1995, 1,213,300 tons. Peak production from the
project was anticipated to amount to 3,700 tons per day (about 1.35 mmt per year), but
annual output has typically been 1.7-1.8 mmt since 1997.
While Polar Lights represents a substantial undertaking, it was always intended as
merely an entree for Conoco into Russia, and Conoco hopes that Russia will become a key
business area for the company in the long run. Thus, Conoco is in the process of negotiating
another, larger project in the same area. This involves an area to the north of Ardala, referred
to as "the Northern Petroleum Contract Area." The project is much larger than Polar Lights,
with $5.0 billion in investment envisioned. This proposed project was approved for PSA sta-
tus under a law passed in November 1999 (see Table 8). It encompasses four oil fields—
Khylchuyu, South Khylchuyu, Yareyu, and Inzerey—reportedly containing 440 mmt of
recoverable oil reserves in aggregate. The fields are located so far north in the Nenets Okrug
that they practically lie on the coast of the Pechora Sea. Conoco is working with LUKoil as
its Russian partner on this major project.
The Timan-Pechora Basin also hosts one of Russia's operational PSAs, covering the
development of portions of the Khar'yaga field by TotalFina-Elf. The French company final-
ized an agreement with Komi-TEK and the Russian government at the end of 1995, covering
the further development of the Khar'yaga field over a 33-year period on the basis of a
production-sharing agreement; the PSA covers two contract zones 38 (IPR, October 2 5 -
November 1,1996, p. 10). Subsequently, this contract was "grandfathered" under the Law on
Production Sharing like the two Sakhalin projects, and TotalFina-Elf declared the project as
"implemented" on January 1, 1999.
Production in the contract territory began on October 2, 1999 (IPR, July 21-27, 2000,
p. 11). In 1999, the Khar'yaga PSA produced 72,300 tons, and in 2000, output was 515,480
tons. Production is expected to amount to about 600,000 tons in 2001. Over 33 years, the
project expects to produce 45 mmt with a total investment of $700-$ 1,000 million, with peak
annual production of about 3.5 mmt (IPR, November 20-27, 1998, p. 10). In 2000, about $80
million was invested in the project, while the budget for 2001 is $294 million (IPR, March 9 -
15,2001).
TotalFina-Elf brought in another foreign partner in 1998, Norway's Norsk Hydro, which
initially took a 45 percent stake. But under the terms of the PSA, upon implementation both
TotalFina-Elf and Norsk Hydro surrendered 5 percent to a local company owned by the
Nenets administration. Thus, TotalFina-Elf now holds 50 percent in the project, while Norsk
Hydro holds 40 percent, and the Nenets Oil Company (owned by Nenets Okrug) holds
10 percent. The share of the Nenets Oil Company is being financed by the foreign compa-
nies. According to the terms of the PSA, 20 percent participation in the project is to be trans-
ferred to a Russian investor.39
38
The field holds an estimated 160.4 mmt of recoverable reserves, of which the PSA contract zone contains
97 mmt.
39
This is going to be LUKoil, following its aggressive push into the Timan-Pechora Basin with the acquisition
of Komi-TEK. Komineft'/LUKoil holds the licenses to the other sections of the Khar'yaga field. TotalFina-Elf
announced in August 2000 that LUKoil would be joining the project with a 20 percent share (IPR, September 1-7,
2000; October 27-November 2, 2000), and a government commission finally approved LUKoil's inclusion in the
project in early 2001 (IPR, February 2-8,2001). LUKoil agreed to pay $26 million to the foreign companies as com-
pensation for funds already spent by the foreign companies.
One of the uncertainties for the project's foreign investors that delayed implementation
was transportation access. Under the terms of the PSA, 100 percent of production is sup-
posed to be exported, but long-term guarantees from pipeline operator Transneft' proved dif-
ficult to obtain. A long-term oil transportation agreement was finally signed with Transneft'
in March 2001 (IPR, March 30-April 5,2001), the first of its kind to ever be concluded with
the Russian pipeline company. The 10-year agreement provides the Khar'yaga project with
firm transportation access for its oil production at a fixed tariff to the export terminal at
Ventspils.
The offshore areas of the basin in the Barents Sea have been slow to be exploited
because of the daunting technological requirements and rigorous climatic conditions.40 But a
number of vessels (drillships and semi-submersibles) have been operating in the area and
have made several substantial gas finds (e.g., Shtokmanovskoye). The offshore Prirazlom-
noye oil and gas field also was discovered. This field is the focus of a pending PSA between
Gazprom and Wintershall (see above and Moe and Jorgensen, 2000, pp. 105-106).
The only "offshore" oil to be produced thus far has been from the Peschano-Ozero
(Sandy Lake) field on Kolguyev Island in the Barents Sea, which yielded its first commercial
oil in 1987 (Shabad and Sagers, 1987, pp. 610-611). This activity is under the jurisdiction of
Arktikmorneftegazrazvedka (Arctic Sea Oil and Gas Exploration Association), a geological
exploration enterprise. Production by this entity, representing mainly the Kolguyev produc-
tion, has remained at less than 50,000 tons annually in the 1990s.
Kaliningrad Oblast
Kaliningrad Oblast, the Russian exclave on the Baltic coast wedged between Lithuania
and Poland, is only a minor oil-producing area, from a small geological structure known as
the Baltic Syneclise. Oil was first struck in 1968, and the first commercial oil moved to refin-
eries in 1975. By 1984, eight fields were in operation, containing more than 150 producing
wells. A total of 17 fields had been discovered by January 1, 1998, of which 15 were being
produced (Azarova, 1998, p. 35). About 80 percent of Kaliningrad's production is from just
three fields, however: Krasnoborskoye, Ushakovskoye, and Malinovskoye (ibid., p. 34).
Output from Kaliningrad Oblast reached a peak of 1.5 mmt in 1985-1986; by 1996, output
was down to about half that, to 0.7 mmt per year, where it has remained since (Table 3).
The principal ongoing development in this producing area over the last few years has
been the offshore Kravtsovskoye field (formerly "D-6"), which is slated to come on stream at
the beginning of 2003. At the initial stage, the field is planned to produce about 500,000 tons
per annum, with peak production amounting to 1.1 mmt per year. This field, which was dis-
covered in 1982, is 15 km offshore in 30 meters of water, with estimated commercial
reserves of 10 mmt (IPR, August 25-September 1, 1995, p. 4).
The local enterprise responsible for development in Kaliningrad Oblast, Kaliningrad-
morneftegaz, became a subsidiary of LUKoil in 1995. Before then, the D-6 field was being
developed by a consortium (known as KANT) that included Germany's RWE-DEA and Veba
Oil as well as Rosneft' (IPR, June 23-30, 1995, p. 7). But it has since become an exclusive
LUKoil project.
40
For background on Russia's efforts to develop its offshore hydrocarbon resources in the Barents Sea region,
see Moe and Jergensen (2000}—Ed, PSGE.
North Caucasus Fields
The North Caucasus is the oldest of the major producing regions in Russia. Production
began over 100 years ago around Groznyy, the capital of the Chechen republic. For the North
Caucausus region as a whole, and generally in all the geographical areas within it, output has
been falling steadily since 1970. In 1990, the region yielded 8.6 mmt, only 1.7 percent of the
Russian total (Table 3). By 2000, production was down to only 3.1 mmt, representing less
than 1 percent of the Russian total.
Crude oil is produced in several different areas, so the North Caucasus includes several
production associations: Grozneft' in Chechnya;41 Krasnodarneftegaz in Krasnodar Kray;
Stavropolneftegaz in Stavropol' Kray; and Dagneft' in Dagestan. Gazprom's local gas enter-
prises also yield a small amount of gas condensate as well.
Early oil production in the region (particularly in the Groznyy area) was from shallow
Pliocene, Miocene, and Oligocene sandstone beds, but the depletion of these reservoirs
caused oil output to reach a peak in the 1930s and then decline. In the late 1950s, new discov-
eries were made in Cretaceous and Jurassic rocks below the Tertiary formations that had
been exploited in the past. This occurred west of Groznyy near Karabulak and Malgobek. As
a result, oil output climbed to a new all-time high of 20.3 mmt in Chechnya in 1970. How-
ever, since then, these new reservoirs have been on the decline as well. By 1990, crude oil
production was down to 4.2 mmt in Chechnya, which had declined further by 1994 to
1.2 mmt (Table 3). Production activities then suffered further as a result of the fighting in
Chechnya, contracting to a mere 0.041 mmt by 2000, or some 0.2 mmt for the Chechen and
Ingush republics combined (Table 3).
Activity by foreign companies in the North Caucasus has been quite limited, reflecting
both the age of the fields and limits of the remaining reserves, as well as the general political
instability in the region. No project with foreign investment in the North Caucasus has man-
aged to go into production, although several were registered.
OUTLOOK FOR RUSSIAN OIL PRODUCTION
In the Main Provisions of Russia's Energy Strategy to 2020, a document adopted offi-
cially by the Russian government in November 2000 (IPR, November 24-30,2000, pp. 6-7),
Russian oil production is projected to continue to expand (albeit quite slowly) over the next
two decades, reaching 335 mmt in 2010 and 360 mmt in 2020. The main oil-producing area
is still envisioned as West Siberia, although its share is projected to fall to 55-58 percent of
the national total in 2020 versus 68 percent currently, as other emerging areas (such as
Sakhalin, Timan-Pechora, and East Siberia) contribute an increasing proportion.
The key element needed to sustain the current turnaround in the Russian oil industry,
after its dramatic slump in the first half of the 1990s, is increased investment. A much greater
flow of investment into the sector is needed to restore idle wells, to increase development
and in-fill drilling, and particularly for new field development. Obviously, a major focus of
government policy in realizing the goals of the Energy Strategy to 2020 is to create a much
more attractive investment environment.
The Russian Energy Strategy to 2020 estimates that to reach the production targets of
335 mmt in 2010 and 360 mmt in 2020, investments of ~$42 billion (in constant ruble-
41
In an attempt to speed up rehabilitation of the Chechen oil fields, Grozneft' officially was transferred to Ros-
neft' in 1999.
equivalent compared to 1999) will need to be mobilized over the next decade, and another
-$80 billion will be needed in the following decade. This is an average of ~$6 billion per
year over the 20-year period compared with the 1999 investment level of -$2.0 billion (see
above). But in 2000, on the back of near-record prices in international markets, investment
levels roughly doubled from the previous year (i.e., ~$3.9 billion was invested). It also
appears that some Russian companies made significant strides in improving the effectiveness
of their investments as well, such as YUKOS.42
In general, these estimates of future investment requirements seem commensurate with
the Strategy's production targets. However, the official 20-year production projection seems
overly conservative given the achievements of 2000. The Russian Energy Strategy to 2020
envisions an average rate of growth in oil production over the 20-year period of only
~0.5 percent per year. Given the strong performance achieved in 2000, combined with imple-
mentation of the Tax Code and PSA regime, it seems that a higher investment level (say ~$7-
8 billion per annum on average) could reasonably be attained over the next 20 years. Com-
bined with continued improvements in the effectiveness (efficiency) of investment, produc-
tion could reasonably reach about 400-425 mmt by 2020; i.e., an average annual rate of
growth in production of 1.1-1.4 percent per year over the 20-year period could be sustained.
But the dynamics of Russian production indicate that a sustained higher rate of growth
(2.0 percent or higher per annum) is highly unlikely in the future because of the huge invest-
ment that would be required in "new oil" production. Although the rate of decline of "flow-
ing oil" (production from currently producing wells/fields) in Russia can be expected to
ameliorate from what has occurred in the recent past as a more normal working situation,
such as regular maintenance, is established in the producing fields, it can still be expected to
decline over the next two decades. A figure of ~4 percent annually on average appears to be
a reasonable estimate of the aggregate "natural" rate of decline. Thus, even to produce 400-
425 mmt of oil in 2020, capacity to produce "new oil" of-175-200 mmt per year in 2010
and -265-285 mmt in 2020 would have to be put into operation. This means bringing on
stream -39,000^5,000 new wells over the first decade and -65,000-70,000 over the second,
necessitating a rate of development drilling averaging -12.8-13.5 million meters per year
over the period.
A key question is from where such a step-up in investment volumes can be obtained,
either for the more modest target of the Energy Strategy or the higher one proposed here. The
main source of investment in the sector will obviously remain Russian companies' own
funds (profits), just as occurred in 2000. Additional sources of finance are planned to come
from foreign direct investment (mainly under PSAs) as well as bank loans (project finance
and other). While the oil industry would be in a good position to finance its own needs if the
bulk of the proceeds earned from exports and domestic sales were to remain at its disposal,
the issue is closely linked to macroeconomic stability, particularly with regard to fiscal and
regulatory measures affecting domestic prices, the practice of delivering to domestic con-
sumers regardless of their ability to pay, export volumes (abroad and to the other CIS coun-
tries), and taxes.
It is clear that tax reform constitutes a major precondition for a sustained recovery in the
Russian oil sector—both by providing sufficient incentive and means to carry out investment
activity. While foreign loans can help (as can foreign investment) in providing the necessary
finance for investment, the bulk of the huge backlog of investment requirements in the sector
42
YUKOS claims to have produced an additional 1 mmt of oil in 2000 just from yield enhancement measures
undertaken with Schlumberger (IPR, April 7-13, 2000, p. 13).
must come from the domestic producers themselves. And the only way that they can self-
finance their own investment is for the government to allow domestic prices to rise (and
thereby increase revenues) and restructure taxes to leave the producers with a higher percent-
age of these revenues.
Russia's current oil production taxation regime is characterized by, relative to interna-
tional industry norms, excessive reliance on volume-based taxes (revenue taxes and excise
taxes) at very high combined rates. Volume-based taxes are insensitive to the underlying
profitability of projects. When they are levied at high rates, the number of projects that can
afford to pay such taxes is very limited. The effect of this system on existing production has
been to shorten the economic life of such production and to accelerate natural production
decline. More importantly, the current system offers little or no incentive to invest in "new"
oil production. This is highly significant because sector stabilization and recovery depend
heavily on investments in "new oil."
Other sector reforms aimed at improving the investment climate are critical as well,
including establishing a comprehensive, clear, and stable legal framework for petroleum
licensing and operations, for both Russian and international companies under conditions of a
market economy. Much of the drive by foreign investors for an effective PSA regime has
been to shelter investment as much as possible from subsequent arbitrary interventions. Of
course, even PSAs are not 100 percent protected from intervention in Russia, as long as there
is no political will and rule of law to keep at bay "inventive" or ill-intentioned taxmen, regu-
lators, legislators, or competitors with large lobbying power. Some elements of such a legal
framework are already in place, but much more needs to be done.
Oil-sector policy reform has been a major focus of debate throughout the period of Rus-
sia's transformation to a market economy. The issue is generally considered critical not only
to recovery of the oil sector, but to performance of the economy overall. Russia still has a
significant oil-sector reform agenda to be accomplished, including: (1) completing legal
reforms and coordinating legislation at Federal and regional levels; (2) dismantling the
remaining policy obstacles to trade liberalization and international crude oil price parity
(e.g., domestic delivery requirements, exports for state needs, export taxes, refined-product
export limits; the hard currency components of oil transport tariffs); (3) encouraging invest-
ments in commercial and physical solutions to constraints on oil exports by providing an
acceptable, stable regulatory framework; (4) streamlining the regulatory and bureaucratic
process to ensure effective implementation of projects; (5) carrying out orderly and transpar-
ent disposition of residual privatization transactions; and (6) strengthening the role of the
regulatory bodies (e.g., the Federal Energy Commission and Anti-Monopoly Committee).
While legal, tax, price, and export reforms have perhaps the highest priority, all items on
the reform agenda require urgent attention. It would be difficult to overstate the importance
of oil-sector reform to Russia's economic recovery. Overall economic performance will
depend critically on performance in key productive sectors such as oil.
The future outlook for foreign investors in the Russian oil sector is always difficult to
predict. But in the general production/investment scenario outlined above for Russia, with
national output growing to 400-425 mmt by 2020, oil production by foreign companies in
Russia is likely to reach -100-110 mmt by 2020, or about 25-26 percent of national output
in that year. This would be realized in the form of a handful of "mega" projects and perhaps
40-50 smaller (JV-type) operations. To reach this level of output, foreign companies would
have to invest around $60 billion over the next two decades. While the role of foreign oil
companies in Russia will expand, it must be recognized that domestic companies will remain
the dominant, driving force in the Russian oil sector.
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Post-Soviet Geography and Economics

Developments in Russian Crude Oil

To link to this article: http://dx.doi.org/10.1080/10889388.2001.10641168

PLEASE SCROLL DOWN FOR ARTICLE

T he Russian Federation (Russia) remains one of the world's major petroleum-producing

•PlanEcon, Inc.; 1111 14th Street, NW; Washington, DC 20005.

Post-Soviet Geography and Economics, 2001,42, No. 3, pp. 153-201.

Fig. 1. Russian oil production, 1987-2000, in million metric tons.

Company 1993 1994 1995 1996 1997 1998 1999 2000

OIL INDUSTRY ORGANIZATIONAL STRUCTURE

Table 2. Russia's Major Vertically Integrated Oil Companies in 2000 a

Surgutneftegaz 40.621 11.144 1,504 489 15.967 -470

O \ r ^ o d < > r ^ < r ) r o r ^ v o o < n i r i r ~ v o o o o o - -

r ^ c n p - - # f o r n ^ t t - ~ p > r ) o q o q p t - - > p p 1 N Is;

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istry of Energy data.

RECENT NATIONAL PRODUCTION TRENDS

— Development drilling (thous. meters)

• - Exploration drifing (thous. meters)

Fig. 3. Drilling in the Russian oil sector, 1970-2000, in thousand meters.

Table 7. Active and Idle Oil Wells in the Russian Federation3

OIL PRODUCTION BY TYPE OF ENTERPRISE

Oil Pricing Policy

Sakhalin Energy (Shell, Mitsui,

Totalfina-Elf, Norsk Hydro

GO&O ^ PU&O ^ fit! 2 C/3 ID

S. Lyzhskoye, North Kozhva

KomsomoFsk Yamal-Nenets Okrug 120 $1.9 Rosneft', Purneftegaz Shell

June 1998 June 1999 June 2000

REGIONAL OIL PRODUCTION TRENDS

Nearly all of Russia's 33 or so oil-producing "regional subjects" of the Federation

Other Siberian Production

North Caucasus Fields

OUTLOOK FOR RUSSIAN OIL PRODUCTION

Azarova, Svetlana, "Kak realizovat' yestestvennyye preimychshestva (How to Realize Natural

tation," International Geology Review, 36, 11.985-996, November 1994.

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