March 10, 2009
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Home / Issue Archive / 2009 / February #2 / "... the End of an Era" – Part Two

№ 2 (February 2009)

"... the End of an Era" – Part Two

The second of two parts, reprinted with permission of the Russian business weekly Expert and the American Chamber of Commerce's AmCham News. Part one appeared in Oil&Gas Eurasia, December / January 2009 available at
www.oilandgaseurasia.com

By Vladimir Drebentsov, Head of Russia&CIS Economics, BP Group

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It is no secret that in recent years the oil sector has seen an increased role for state-controlled companies. I will not focus on the details of this process – this topic has never left the front pages. Major changes have taken place in the list of leading Russian oil companies. Private companies Sibneft and Yukos disappeared, and most of their assets were taken over by state-owned Gazprom (Gazpromneft) and Rosneft. Mostly as a result of this redistribution of assets, Gazprom, which was in tenth place in terms of oil production in 2003, moved to fifth place last year. And Rosneft during these four years made even more impressive progress, moving from eighth place to first. The share of these two companies in total oil produced in Russia in 2007 amounted to 32 percent.


Some critics would certainly note that state-owned companies are usually less efficient compared to private ones, and, therefore, that the increased role of state-owned companies in this sector may lead to a slower rate of development, as opposed to the scenario when most of the assets would remain private. But I won’t say that. I would rather point to another consistent pattern: both theory and international practice show that the attitude of state-owned and private companies to increasing production often differ. And the difference is considerable. Private companies, given appropriate economic motivation, always aim to increase production. This is their only method of staying on the market and remaining competitive.


But governments and the companies they own may have other objectives. For example, manipulation of production aimed at maintaining a target price level, as done by OPEC countries. The difference in the behavioral pattern of OPEC companies and, until recent events, mainly private companies operating outside the cartel, may be tracked in Charts 5 and 6. Outside OPEC, production generally was growing over the last forty years. And within OPEC it is noticeable production only grew during periods with lesser discipline.


One can reasonably object that in Russia and other producing countries on the territory of the former Soviet Union this behavior was not observed, even when all the production was controlled by the government (during Soviet period). Indeed, Chart 7 demonstrates this well. The 1989-1999 drop in production was due to entirely different reasons.


But is it possible to count on this trend continuing in the future (notwithstanding the current production decline)? We would like to hope so. But changes are also possible. A number of recent steps by the Russian government (the Law on Strategic Sectors, the Subsoil Law, and assigning some of the licenses to the state-owned companies without tenders) limit the access of foreign and private Russian investors to the development of large new oil fields. According to RBC information, the government has prepared a draft resolution on establishing a national reserve fund of mineral resources, which is aimed at preserving resources for future generations.


It can be expected that these measures will mean new constraints on increasing oil production in Russia. But could this be for the better? Does production need to increase, at all? Considering that 70 percent of oil produced is exported as crude or oil products, perhaps it is better to keep the precious non-renewable resources at their origin? There are more and more frequent warnings about the “resource curse,” “Dutch disease,” and other economic and further dangers related to massive inflow of oil dollars.


Of course, the right to decide on the destiny of natural resources belongs to the national government. And only a national government can decide what is best for country’s interests. We can simply look around and see how this issue is handled by other governments, in countries that have non-renewable natural resources.


Oil in the Ground or Money in the Bank?
A detailed review of the efficient use of revenues from mineral resources would be a separate story. I will limit myself to a few comments.


The calls for a stop to producing too much oil on the grounds that the country cannot cope with the influx of money are akin to religious asceticism. If you cannot overcome temptations (for example, gastronomic), mortify the flesh. Or alternatively, would learning to eat right do the trick? In this way you could avoid obesity (the Dutch disease).


Similarly, discussion of the resource curse often smacks of the self-comforting fatalism of “the rich also cry” sort. What about looking at the wealth not as an evil fate but as a pass to the world of opportunities? Of course, the wealth can be squandered, but it is hardly inevitable. It is true that few counties have managed to make good use of the revenues from large-scale mineral wealth development. But there are positive examples, even in the developing world. Suffice to mention Botswana and Chili. Let alone developed countries such as nearby Norway or Holland. The latter has, of course, had the eponymous disease. But it has not turned the country against producing gas.


That brings us back to the question: What should we bequeath to the coming generations: dollars or deposits? Let us look at the answer preferred by the oil-producing countries.

Arguments used by some OPEC countries to justify restrictions on oil production include the need to preserve mineral resources for future generations. In particular, Saudi Arabia says that some of the deposits discovered in the country are not developed specifically for this purpose (however, some skeptics say that these deposits simply do not exist). But even if we dismiss the doubts about Saudi sincerity, the fact remains that OPEC cuts production only when the oil price goes down. And they do not mind ramping up production if it does not pose a risk to the price. It seems that OPEC’s understanding of its economic benefit is that monetization of reserves at the right price is beneficial for future generations. And it is difficult to challenge this understanding when you see the petrodollars diversifying the economies of Gulf States (though not optimally) and their property overseas.


A similar approach is used by such countries as Great Britain, Canada, Norway, and the U.S. These countries too have their share of academic reasoning that oil should be left in the ground. But this was not the choice made by the policy-makers. Neither Great Britain nor Norway regret the fact that most North Sea resources have been extracted in the forty years of development (In Great Britain, production peaked in 1999 and this year the country has become a net importer of oil. In Norway, oil production peaked in 2001). However, the governments of both countries are actively encouraging the development of remaining North Sea reserves.


The reason behind it is simple. Investment in oil production provide a boost for other sectors of the economy and oil revenues give greater opportunities for economic development than oil left in the ground. In addition, for economies less diversified than the British and Norwegian economies, development of oil reserves can be a way to escape from oil dependency eventually. Russia’s neighbors, Azerbaijan and Kazakhstan, adhere to the policy of active oil development. The governments of these counties have created oil funds and believe that it is better to leave financial resources to future generations instead of natural resources, no matter how valuable it may currently be.


Sometimes the U.S. is used as a counter-example. The superpower is holding back its oil reserves. This may well be a misconception. The U.S., it is true, for some time followed a policy of oil field conservation for war emergencies. But it happened between the First and Second World Wars and is now relegated to a distant past. What really exists in the U.S. is a moratorium on offshore oil and gas exploration and production covering most of federal shelf zone (beyond six miles off the coast, as water areas up to that boundary are owned by littoral states), including the Arctic natural reserve along the Alaskan coast.


Moreover, until recently, it had been a double moratorium: the Congress imposed it in 1981, and President George H. W. Bush supplemented it by an executive order in 1990.


It should be noted that the moratorium was not imposed to conserve oil for future generations, but was an outcome of efforts by environmentalists to ban offshore oil production supported by littoral states (in particular, by California and Florida, concerned about tourism revenues). Most calls for imposing a moratorium were based on a single incident (though a major one) involving a sub-sea pipeline leak as a result of an earthquake in California. Some will, no doubt, suspect hidden geopolitical designs in the activities of environmental groups. However, in my opinion, this would be convincing only for an ardent fan of conspiracy theories.


The President’s moratorium was supposed to last until 2012. But this July, it was lifted by President George W. Bush and in September, the House of Representatives initiated discussions to lift the moratorium imposed in 1981. Even Democrats who for many years had been firmly in support of keeping the moratorium in place changed their position and expressed a willingness to lift the offshore drilling ban. The only remaining point at issue between them and the Republicans is whether drilling should be allowed anywhere or a fifty-mile conservation zone should be kept along the coast.


To conclude this discussion, I will offer another argument against the rationale of leaving the oil in the ground for the future. The advocates of this approach explicitly or implicitly proceed from the assumption that the usefulness and therefore value of oil as a nonrenewable resource is set to increase. In other words, oil, as long as it is available, will always be in great demand. At first glance, the logic is impeccable. However, these expectations may be unrealistic. Mica was considered a useful natural resource before glass was invented. Rubber trees were valuable before rubber was invented. The list may go on. But it is as clear as day that any resource is in demand until there is a better substitute.


From this perspective, oil is just a very convenient feedstock to produce motor fuels, some plastics and bitumen as long as there is no alternative fuel for the internal combustion engine or other mass-produced engines using other energy conversion principles. But that does not mean that they will never materialize. Despite the skepticism of some wellknown economists, the breakthrough development of bio fuels on the basis of biomass sources which are not in competition with food production has a good chance of success. A little history is appropriate here. In the early twentieth century, British engine builders, after reviewing the first German internal combustion engine, concluded that steam was the thing of the future and made a spectacular blunder. Not to speak of the coalto- liquids technology used in the production of plastics. The Chinese Government is making significant investments in the development of this technology.


Oil majors are also keeping up the pace of investments in alternative energy sources development. No one wants to remain the leading stone producer when the Stone Age ends. And, as BP economists like to say, the Stone Age ended not because they had run out of stones. Is it then worthwhile to hoard them?

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