WASHINGTON, DC – Unless major reform is undertaken, Russian oil production could begin a sharp decline after 2015 to 2020, says Thane Gustafson, senior research director for IHS and a professor of government at Georgetown University. Gustafson was speaking at the IHS Forum in Washington on November 13.
Gustafson is the author of a new book, Wheel of Fortune: The Battle for Oil and Power in Russia. The book is based on intensive research, first-hand observation, and interviews with key players over the course of two decades and offers a detailed history of the oil industry's evolution since the breakup of the Soviet Union and a look at its uncertain future.
“Legacy [Russian] assets are starting to run down,” said Gustafson. Western Siberia, which produces most of Russia’s oil, peaked in 2007. Lukoil has pulled out all stops and has succeeded in halting production decline, but I think even they would agree this is temporary. Additional oil is deeper, harder to get, and less profitable because of higher production costs.”
He continued, “The government’s dependence on oil and gas has become acute. Forty percent of the Russian budget comes from oil revenues.”
If the state’s precarious relationship with the energy industry can be reformed, oil remains Russia’s best hope, he said. Reform is problematic as long as Vladimir Putin is president, but long term, the situation needs to change.
“Russia is not running out of oil, but it is running out of ‘cheap oil,’—as the ‘legacy’ assets inherited from the Soviet Union begin to decline,” Gustafson said. “They have come to the end of one chapter and moved on to another. And so far that new chapter is full of blank pages.”
Russian oil production is on track to increase by about one-and-a-half percent this year, but only at the price of a sharp rise in capital spending. Investment in the oil fields increased 34% in 2011 to a record $31 billion and could exceed $35 billion this year. To prevent declining production the industry will have to expand beyond its Soviet-era fields to more remote, geologically complex and cost-heavy areas, such as the Arctic offshore, where it has little experience and know-how.
“Over the past 20 years, the oil industry and the state have fought for control,” Gustafson said. “The result today is an industry that is overtaxed, overregulated, and under-motivated to prepare for the challenges ahead.”
A decline in oil revenues could usher in a major crisis, forcing cutbacks to major spending programs such as pensions and subsidies that underpin the stability of the Putin regime. In such a crisis the state would be forced to confront the difficult choice it has avoided for so long—whether or not to lessen the tax burden on the oil industry and enable it to invest in the next generation of fields and technology.
Gustafson said that many in Russia’s government realize that trouble lies ahead but that consensus is lacking on how to move forward. A reduction in oil revenues could devolve into a power struggle between interest groups over shrinking oil rents. Or Russia’s leaders could pursue a course of comprehensive reform to reduce the state’s dependence on oil revenues while stimulating changes in the oil industry itself, so as to encourage the innovation and entrepreneurship that will bring about its renaissance.