Towards an energy strategy

The Russian government's long-term energy strategy to 2020 was sent to the Cabinet for discussion last month and should be approved before the summer holidays. The development of the energy sector remains a priority for the Kremlin, accounting for half the economy and just over three-quarters of stock market capitalization.

"Russia will always be primarily a raw materials exporter. It is where Russia's competitive advantage lies and despite the efforts to diversify the economy the Kremlin will never lose sight of the importance of these resources to Russia's future development," says Rory MacFarquar, an economist with Goldman Sachs.

President Vladimir Putin's administration has developed a habit of consistently under-estimating Russia's progress. The draft is short on detail and modest in its predictions but lays out a plan for steady improvement and a more efficient, market-oriented Russia.

The strategy offers a pessimistic and an optimistic long-term projection for oil and gas output and the investment required. Having languished at about 6 million barrels per day (bpd) for most of the past decade, oil output growth is expected to reach 8.9 million to 9.8 million bpd by 2010 and 9 million to 10.4 million bpd by 2020. This compares with the 8.1 million bpd expected by the end of this year, says deputy prime minister Viktor Khristenko.

The oil companies' own estimates are significantly more optimistic and already easily outstripped the energy ministry's last guess at growth rates in 1999. Since then annual oil production growth has been running at 7% to 10% a year while the leading companies have put in double-digit gains for most of the past four years.

The energy ministry's estimate for gas production may be closer to the mark as the bulk of Russia's gas is produced by state-owned Gazprom: Khristenko estimates gas production growth of 635 billion to 665 billion cubic metres (bcm) by 2010 and 680 to 730 bcm by 2020, against the 595.3 bcm produced in 2002.

The energy ministry is expecting the biggest gains to come from more efficient energy use. Companies never had to pay for power in the past and waste huge amounts of energy: Russia uses twice the amount of power per unit of production than the US.

More significant than the numbers is the fact that the government is attempting long-term planning in the first place. With the worst economic problems already solved, growth has forced the Kremlin to focus on upgrading the country's infrastructure. Thanks to the massive growth in oil production the oil export pipeline network is at full capacity.

"Pipelines are the key issue for Russia and can be used to control oil production. Russia is already producing enough to meet its domestic needs and all the excess will be exported," says Kaha Iknovalitsa, an oil and gas analyst with Troika Dialog. "The existing network is already struggling to meet the demand for space."

Here the energy strategy is more decisive and ambitious. The Blue Stream sub-Black Sea gas pipeline supplying Turkey with Russian gas went on stream at the start of the year and a plan to build another gas pipeline to northern Europe via Poland is well in hand. Both pipelines will complement the Soviet-era gas pipeline to eastern Europe running through the Ukraine.

At the same time Russia's state-owned oil pipeline monopolist Transneft has begun ambitious expansion plans for the Baltic Pipeline System (BPS). In March Transneft vice-president Sergei Grigoriev said the company was in the final stages of negotiating $1 billion of financing to boost BPS's capacity from 240,000 bpd to 840,000 bpd and bring Transneft's total export capacity to over 4 million bpd.

The strategy also gave the go-ahead to two new pipelines that will open new strategic markets to Russian crude exports. After initially casting scorn on the idea of privately owned pipelines, prime minister Mikhail Kasyanov gave the nod in April to one being built to link Russian supply with Daqing in China and in May another to Murmansk in the northwest of Russia.

The $2.5 billion Chinese pipeline will carry about 600,000 bpd and the $4 billion to $5 billion Murmansk pipeline about 2 million bpd. Together they will double Transneft's export capacity as well as opening up the Chinese and American markets to Russian crude oil exports for the first time. And the document hints that a more ambitious pipeline to Nakhodka on the Pacific coast will eventually be built that would open Japan to Russian oil exports.

One disappointment was the lack of detail on restructuring the gas sector. In principle a wholesale gas market is supposed to be created by 2005 and a retail market by 2006/07 but the energy strategy was ominously silent on how the gas market reforms should proceed.

"There has been no official decision on what to do with Gazprom and because of all the infighting it is too early to say which way it will go - remaining a state foreign policy tool or being broken up," says Troika Dialog's Iknovalitsa. "But it is clearly not in Putin's interests to escalate the fighting and nothing will happen until maybe after the elections."

However, the strategy calls for gas tariffs to be increased. Gazprom currently charges $21.50 per 1,000 cubic metres, but will be able to charge $40 to $45 by 2006, and $59 to $64 by 2020. Given the Kremlin's habit of underestimating targets, analysts are sceptical about the strategy's guesses.

"The tariff hikes in the strategy are very modest," says Stephen O'Sullivan, head of research at United Financial Group. "I suspect there is a lot of politics behind the estimates. No-one wants to call for big tariff hikes on the eve of an election. We estimate that Russia will reach the strategy's 2010 tariff levels as early as 2006."