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Pushing up Oil and Gas Price levels

Despite the resurgence in world oil prices and recent increases in domestic gas and power prices, Russian energy has been beset by low prices which discourage output and encourage wasteful consumption.

Despite the resurgence in world oil prices and recent increases in domestic gas and power prices, Russian energy has been beset by low prices which discourage output and encourage wasteful consumption. The current slump in domestic oil and oil products prices, however, is largely due to Russia's decision to co-operate with OPEC in the first half of this year in restraining exports.
Its co-operation was widely thought to be cynical symbolism, since it consisted of taking last year's export level at its traditionally high level in the third quarter and promising to reduce it by 150,000 barrels a day during the first quarter of this year when winter weather always restricts shipments.
Yet the government has now extended its co-operation with OPEC for the second quarter, provided world oil prices do not climb higher. The 70 per cent drop in domestic crude prices in the past three months, at a time when the economy is growing, shows the export restraint has been real; it has created a glut at home.
Prices will recover later this year when Russia, and probably OPEC itself, ceases to restrain production and exports, though the temporary dip in prices may encourage further consolidation. The oil industry is already dominated by 11 large vertically integrated companies which account for nearly 90 per cent of crude production and nearly 80 per cent of refining.
However, there is still scope for more consolidation in several directions. First, many of the 100 or so small independents producing less than 10m tonnes of oil a year will probably end up in larger groups. Second, the government is due to sell 20 per cent of the Slavneft oil company; one logical bidder would be Tyumen Oil (TNK), which already has a 12 per cent stake in Slavneft.
The government is also to sell 6 per cent of Lukoil to foreign investors. Still 100 per cent in state hands is Rosneft, but its assets are largely those that no one wanted in earlier privatisations.
The third possibility is consolidation among the larger integrated companies, though, for the moment, they seem more interested in linking up with foreigners than with each other. Lukoil and Yukos, respectively the number one and two oil companies, are actively looking for downstream acquisitions in central Europe from the Baltic to the Balkans.
Sibneft is focused on using the expertise of western oil service companies to improve recovery rates at home in Siberia.
TNK, meanwhile, gives the impression of being ready to sell out to a western producer, such as BP. But there is a performance gap opening up within the Russian oil companies which could lead to better-managed companies taking over the worse-managed ones.
Yukos and Sibneft, for instance, have lower production costs and higher growth rates than Lukoil and Surgut. This is one reason why the former disagrees with OPEC on the need for production restraint, and the latter sides with OPEC.
One of the reasons for the surge in Russian oil production is that domestic prices are not too divorced from world levels. Though much lower now, the domestic crude price is, at between Dollars 5 and Dollars 6 a barrel, still about a quarter of the world price.
Conversely, a big factor behind the fall in Russian gas production is that domestic gas prices bear very little relation to export prices. In the first half of last year, the domestic price to industry (itself higher than to households) was Dollars 14.5 per thousand cubic metres, according to the International Energy Agency (IEA), compared with the Dollars 136 per thousand cubic metres which Gazprom, Russia's virtual gas monopoly, could get by selling to western Europe.
Small wonder, then, that Russian natural gas production and domestic sales should have fallen.
"Price reform is probably the single most important policy for gas - and perhaps the entire energy sector - in the first decade of the 21st century," says the IEA in its latest Russian energy survey. The government has laid out a plan to increase prices to European levels by 2007. But it is hard to see prices rising 250 to 350 per cent in 2003-05 (compared with 2000) when increases of only about 20 per cent have been considered politically possible this year and last.
Another price, which needs increasing, is that paid to oil companies for the substantial quantities of gas, which come bubbling up with their oil. This so-called associated gas requires cleaning before being put into the Gazprom pipeline network.
In Siberia, this has been done by Siberian-Urals Oil and Gas Chemical company (Sibur). But this subsidiary of Gazprom has offered such a low price for associated gas that many oil companies have preferred to flare it on the spot rather than gather and transport it to processing plants.
Gazprom has recently taken full control of Sibur, charging the latter's top management with asset-stripping.
While Gazprom may not be interested in higher prices to entice foreign investors, its electricity counterpart, United Energy Systems (UES), is.
Again, there is a plan to raise electricity tariffs by 160 per cent in real terms in 2003, and a further 160 per cent in 2005 in order to cover the long-term costs of generators, to reward maintenance and to entice investment in new capacity.
However, in contrast to Gazprom, UES has at its head a man who is prepared to make room for foreign investors. Anatoly Chubais, the privatisation crusader of the Yeltsin era, is pushing ahead with his plan to create competition in electricity. This involves carving up UES, which is 52 per cent owned by the government and 48 per cent by various Russian and foreign private investors.
A federal grid company has already been set up to run the high-voltage transmission system under the ownership and management of the state. But UES' 72 regional energy generators are to be formed into separate companies to compete to supply the wholesale power market. Eventually, independent generators would be allowed to enter the market by getting non-discriminatory access to the state-run grid.
Some of these independent generators will be foreign, hopes Mr Chubais. "We cannot wait until the end of the reform process to interest such investors." he says. So in addition to signing a joint venture deal with Eon of Germany, he is in talks with Electricite de France, Enel of Italy, Endesa of Spain and various US companies.

Author: David Buchan

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