Russian oil industry's upstream volume growth to continue

Nov 13, 2001 01:00 AM

The Russian oil industry has undergone extensive changes in the last two years and looks set to continue the upstream volume growth that began in 2000, according to a report published by Credit Suisse First Boston (CSFB). Russia's crude output could reach 8 mm bpd by 2005, says the report, entitled "Russian oil industry: The bear is back".
The report also considers exports from the former Soviet Union, including crude and products, and says they could increase by 1.5 mm bpd between 2000 and 2005, with Russian crude accounting for two thirds, or 1 mm bpd, of this projected increase. During 2001, FSU exports will account for roughly 80 % of total expected non-OPEC supply. The report adds that for the 2001-2005 period, the FSU will account for at least 50 % of all non-OPEC supply growth.

Crude export increases of the size that CSFB is projecting for Russia could prove to be OPEC's "most significant market share challenge" since the 1985-86 crash, according to the report. "Russia's expected growth will bring forward the time at which OPEC will need to confront the trade off between price and volume," it says. "OPEC's headache is born of the fact that after (the rouble's) devaluation (during the 1998 Russian economic crisis), Russian oil industry economics have improved considerably, placing Russia firmly at the bottom of the non-OPEC cost curve. Growth in Russian production cannot easily be derailed."
Russia is the largest non-OPEC crude reserve holder and the report goes on to say that it considers the current Western estimate for Russia's proved oil reserves of 49 bn barrels to be "much too conservative" and suggests that existing proved reserves are closer to 60-70 bn barrels. Furthermore, it also points out that Russia and much of the FSU "is extremely under-explored and existing discoveries remain under-developed."
It cites the fact that most current Russian production is from the traditional western Siberian area and notes that there remain vast areas of highly geologically promising acreage, "notably in Eastern Siberia, which have never seen a drill bit." Whatever constraints to further FSU volume growth may arise, it adds, a lack of reserves is not likely to be one of them.

The real problem facing Russia and the FSU is that of export capacity constraint. But the report says that there is sufficient spare capacity in the FSU system to allow the 1.5 mm bpd increase in exports to reach the market, although continuing export growth after 2005 will require more export capacity than is currently planned.
The main increases in export capacity from the FSU in the next few years are likely to be through the CPC pipeline (560,000 bpd), the Baltic Pipeline System (240,000 bpd) and the Druzhba-Adria linkage (100,000 bpd), says CSFB. In the longer term (post-2005), the construction of a major pipeline from Siberia to China and the proposed Baku-Tbilisi-Ceyhan (BTC) pipeline will allow Russia and the Caspian Sea producers to increase exports.
Upstream economics in Russia and the FSU as a whole has changed dramatically since the devaluation of the rouble in 1998, CSFB points out, noting that with 90 % of operating and capital costs denominated in roubles and export sales in dollars, the industry's cash flows and balance sheet improved very substantially in a relatively short period of time. "In a surprising development," the report says, "most Russian upstream companies became free cash-flow positive by the end of 1998 with oil prices at their 12-year lows."

The report notes that net lifting costs in Russia in 2000 were estimated at $ 2 per boe, down from $ 7.25 per boe in 1997 and compared to an average cost for international oil majors of $ 4 per boe. It says that even more important is the estimate that the average level of maintenance capital expenditure (capex) in the Russian sector is currently $ 1.50-1.75 per boe.
This allows Russia "to be able to replace production at oil prices significantly below mid-cycle (which CSFB puts at $ 17 per barrel) levels," it states. "In other words, the price has fallen at which Russian oil companies are likely to curtail production growth. This hypothesis remains as yet untested by reality, however, and this has been derived by (CSFB) from economic analysis."
Total capex in Russia in 2000 has risen in both nominal terms and in terms adjusted for the devaluation, the report says, adding that per-barrel expenditures in 2000 were roughly twice the replacement levels, hence the substantial increase in crude oil production.

The report also looks at taxation of the Russian oil industry, which it says has changed for the better, with new laws due to take effect in January of 2002. It notes that the new tax regime provides for generally lower effective taxes when oil prices are below mid-cycle levels. Above mid-cycle, it adds, the effective tax take rises, but given the substantial improvement in the industry's financial position, this is now less of a concern.
"By far the most important point regarding the new tax system is that it should ensure a much higher level of predictability for the industry," the report says, "making long-term planning easier and allowing larger projects to be undertaken with more confidence, we think."

Source: NewsBase
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