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Chicago Tribune
December 9, 2001
In Russia vs. OPEC, U.S. gets the win
By Melita Marie Garza
Tribune staff reporter

In a turbulent global energy market, Russia is emerging as a powerful player whose contentious relations with the Organization of Petroleum Exporting Countries increasingly tend to serve U.S. interests.

Over the past few weeks, Russia's repeated rebuffs of OPEC's demand for production cuts have dragged down already weak oil prices. Finally last week, Russia, which produced 7.2 million barrels per day in October, agreed to cut crude oil exports by a modest 150,000 barrels a day.

The fig leaf was enough to assuage OPEC and may be enough to serve as a trigger for the cartel's planned cut of 1.5 million barrels a day on Jan. 1, but it failed to reverse the downward slide of the market, which is burdened by huge oil inventories. West Texas Intermediate Crude for January delivery is down 65 cents a barrel, at $19.04, since Russia's announcement.

Barring a Mideast conflict that could disrupt oil supplies, that translates to continued low prices for gasoline and other petroleum products, analysts say.

"Russia provides an increasing flow of non-OPEC oil," said Matthew Sagers, director of energy economics for Eurasia and Eastern Europe for Cambridge Energy Research Associates.

"Although Russian and Caspian oil are going to be no substitute for Mideast oil, Russia changes the dynamics of the world oil market, much the way North Sea oil did. The Mideast game is a big game, but it is no longer the only game in town," Sagers said.

Russia's emergence as a sophisticated oil producer and OPEC provocateur comes at an auspicious time for the United States.

Anything that serves to keep oil prices low, experts say, provides powerful medicine to the ailing U.S. economy. A full year of oil prices as low as $20 a barrel, says Wells Fargo & Co.'s chief economist, Sung Won Sohn, would do more to fuel economic recovery than the economic stimulus package being debated in Washington.

OPEC's mission of keeping oil prices high is being thwarted by more than just Russia's production. Norway and Mexico have also emerged as major non-OPEC oil producers, and Norway last week was still refusing OPEC demands to specify the size of its own production cut next year.

The recalcitrance of Russia and Norway comes as the world's fragile economies have sharply curtailed demand for oil. The Sept. 11 terrorist attacks clobbered economies worldwide, taking a major bite out of airline travel and demand for industrial goods. So cheap is the price of crude oil now that most analysts expect U.S. gasoline prices to drop below $1 a gallon in the near future.

With weakened demand, the ability of non-OPEC producers to pump out millions of barrels of oil a day exerts stronger-than-normal pressure on prices.

"It's safe to say OPEC and Russia wouldn't be having this dialogue if the world wasn't in recession," said Amy Myers Jaffe, senior energy adviser at the James A. Baker III Institute for Public Policy at Rice University. "Rising demand would have made room for everyone."

Russia is the world's second-largest oil producer after Saudi Arabia and holds the eighth-largest oil reserves. Mexico and Norway each produce about 3.1 million barrels per day.

A convergence of events has led to Russia's new power in the oil market. Chief among them is the fact that Russia has finally cleaned up its corporate act, successfully privatizing most of its oil industry and making inroads against corruption. In some ways, Russia is the accidental actor in this drama, having begun to rebuild its petroleum industry just as demand for oil fell.

Foreign investment easier

While it is still not easy for foreign oil companies to do business in Russia, most analysts agree that the climate is much improved.

"There is now a structure for investment--it's a lot easier to do business there than it was in 1992 and 1993, just after the collapse of the Soviet Union," said John Kingston, director of global oil for Platts, an energy information service.

Despite its recent progress, Russia is still producing significantly less oil than it did when it was a communist regime. Russian oil production peaked in 1987 at 11.5 million barrels per day. At that time, it was a state-controlled operation, run through associations similar to farmers' cooperatives.

"It was their chief cash crop and they produced like crazy," Kingston said. "They didn't practice proper petroleum engineering procedures. There is a way of doing proper well management that extends the life of an oil field; it's not like sticking a straw into a bunch of lemonade. But the Soviets' whole idea was `let's produce as much as we can.'"

After the collapse of the Soviet Union, production began to plummet. "It was chaos," Kingston said. "And their chaos took a lot of oil out of the market, ramping up prices."

Russian oil is referred to as Urals crude and is actively traded in two separate markets, one out of the Mediterranean, another out of northwestern Europe.

"Their influence is big now because they are bringing on more product at a time when the market doesn't need more product," Kingston said. "People with entrenched positions, namely the OPEC countries, are saying `you are not supposed to do that.'

"The Russians' point is that they have spent a lot of time and effort to make their country a decent place to invest and they don't want those strides reversed," Kingston said.

Jaffe, of Rice University in Houston, says Russia is influential in large part because of its potential future production capabilities.

"OPEC recognizes [Russia's] ability to ramp up production and they are trying to prevent Russia from taking any increased market share," Jaffe said. "It's not so much that Russia is going to set the price for oil. They'll take market share at either the expense of prices, or at the expense of OPEC."

U.S. benefits

Either way, it would appear to be a win-win situation for the U.S.

"We get to pay lower prices and we get the benefit of lesser OPEC power in the market," Jaffe said. "But if you are an American strategic thinker, if you are thinking of world stability, a $10-a-barrel oil world is a very unstable world. Poverty in the Middle East would be enhanced, and so would support for radicalism."

There is some question whether Russia has the ability to stop production, even if it wanted to. "This is not a country that has a state oil company or oil ministry that can snap its fingers and control its production," Kingston said.

Russia now has fewer than 10 major integrated oil companies, which were formed when the old petroleum associations were privatized and combined with regional refineries and service stations, said Tom Wallin, president of a market-analysis firm called Energy Intelligence Group.

Government controls exports

Yet Russia's entire export system remains state-controlled, through Transneft, the state-owned company that runs the pipeline system, Wallin said.

The private companies must obtain export permits on a quarterly basis that are sometimes denied in the wintertime because of Russia's internal demand for oil, Wallin said.

But Russia's preference is to sell on the international market. Oil remains Russia's biggest hard currency earner, and internally it is one of the biggest tax revenue producers for the Russian government, which has yet to impose a personal income tax, Jaffe said.

By agreeing to cut exports of crude oil, not production, Russia can keep energy exports flowing, though they are likely to be in the form of home heating oil, which was not included in its OPEC offer, said Bill O'Grady, energy analyst for A.G. Edwards & Sons in St. Louis.

Some experts question Russia's ability to stand up to OPEC over the long term.

"The Russians are in a vise," Jaffe said. "They need to have moderate to higher prices to help their own economy. Yet, are they going to let these small countries of OPEC tell them what they can do with their own economy? They've privatized; are they going to respect the privatization?"

She sees Russia's recent two-step with OPEC as a test of the country's philosophy going forward.

"It goes way beyond OPEC," Jaffe said. "It goes to the issue of how much government regulation there will be in the private sector in Russia."

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