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Moscow Times
January 28, 2003
Kremlin, Big Oil on Collision Course
By Catherine Belton
Staff Writer

Russia's powerful oil barons are locking horns with the government in a high-stakes battle over new export routes that threatens to alter the economic and political landscape of the country.

In an unprecedented display of unity, the heads of the nation's largest oil companies in the last two weeks have collectively petitioned President Vladimir Putin's administration at least four times to relax the state's iron grip on the national pipeline network and allow them to erect their own export routes.

Oil chiefs say that if the government, via state pipeline monopoly Transneft, is unwilling or incapable of unblocking existing routes, then it should stand aside while they ensure export capacity keeps pace with surging production and inroads are made into crude-thirsty China, Japan and the United States.

But if oil companies are allowed to have their own pipeline networks, the precedent would make it difficult for the government to keep control of Unified Energy Systems' power grid and Gazprom's gas pipeline network in the course of restructuring, analysts said.

The lobbying campaign has already increased tensions between the increasingly powerful oil magnates and a Kremlin increasingly reluctant to cut them any slack after their wealth-grabbing orgy in the 1990s. The Kremlin sees making sure Transneft keeps its monopoly as the least costly way to keep the oil companies in check. But the crude oligarchs are straining at the leash.

Earlier this month, Prime Minister Mikhail Kasyanov fired a warning shot across big oil's bow, announcing during a visit to Murmansk that all major pipelines would remain under state control -- even ones not yet built.

The announcement was an explicit reference to a grandiose project launched to much fanfare last year by four of the top five oil companies -- LUKoil, Yukos, Tyumen Oil Co. and Sibneft -- who want to build a $3.4 billion to $4.5 billion pipeline to the Arctic port city of Murmansk to capitalize on warming ties with the United States by shipping crude directly to the U.S. market.

Yukos CEO Mikhail Khodorkovsky reacted with impatience to Kasyanov's statement last week, slamming the government for moving toward what he called "a Saudi Arabian-style government" of overblown bureaucratic control.

"The most acute problem that exists today is between the entrepreneurial class and the bureaucratic class," he told Reuters during the World Economic Forum in Davos, Switzerland. "Today, a large number of bureaucrats are pushing us in the Saudi direction.

"I thought the state acknowledged a long time ago that the private sector is more effective than the state sector. But the pipeline issue has become a stumbling block," he said.

Khodorkovsky warned that Russia risked losing up to 1 million barrels per day of exports, currently shipped out through more expensive river and rail routes, if oil prices fall a third to $20 and no action is taken to free up gridlocked pipeline capacity.

He said it was time for the government to let private companies build their own pipelines.

However, TNK chairman Viktor Vekselberg warned against getting bogged down over ownership questions, insisting that the main concern is to find ways of encouraging private investment in pipeline projects -- even if the state continues to control them.

"Of course the pipeline system is the prerogative of the government," Vekselberg said in an interview. "The issue is entirely different. The state has to create an effective stimulus for private companies ... to take part in the development of infrastructure systems."

One way of doing this, he said, would be to create a mechanism whereby oil companies paid reduced tariffs on crude shipped via Transneft in return for and in proportion to investments.

That proposal was echoed in a letter sent to Kasyanov last week by the heads of LUKoil, Yukos, Surgutneftegaz, TNK and Sibneft, a copy of which was obtained by The Moscow Times.

In their letter, Russia's five biggest producers told Kasyanov that they were ready to go ahead with the Murmansk project independently if they got the "necessary state support" or to finance and guarantee oil supplies for a state-owned version in return for lower tariffs and a waiver on equal access rules for pipelines.

Vekselberg said if oil companies meet their declared production targets, Transneft would be overwhelmed. "We need to start building right now," he said.

Oil majors are already facing bottlenecks despite planning for most of their production growth to come in the spring. Crude production grew 10 percent last year to a post-Soviet high of 379 million tons and is expected to grow nearly as much this year. Another reason oil majors are in a hurry to increase export capacity is that they are losing money on the domestic market, where prices are between $5 and $6 per barrel, just a fraction of world prices.

But the government is not expected to discuss the Murmansk project until April, and it is not expected to choose between two other controversial pipeline projects -- one to China, which is backed by Yukos, or one to Nakhodka on the Sea of Japan, which is backed by Transneft -- before March.

In the meantime, the pace and veracity of lobbying is expected to be intense -- and Transneft is already preparing for battle.

Transneft is asking the government to allow it to quadruple the capacity of the Baltic Pipeline System, which it owns and operates, to 50 million tons per year, while pushing the construction of the Angarsk-Nakhodka pipeline instead of the Yukos-backed pipeline to Daqing, China.

Transneft argues that the $5.2 billion, 3,900-kilometer Nakhodka project, which would have a capacity of 50 million tons per year, is more important strategically than the China link because all Pacific Rim countries, including Japan, the Koreas and South and Central America could be supplied from Nakhodka.

Yukos' $2.5 billion, 2,200-kilometer pipeline would be dedicated to China and have a capacity of only 30 million tons per year.

Despite not having any guaranteed crude supplies for the Nakhodka pipeline, Transneft appeared to gain the advantage when a visiting delegation of Japanese government officials gave it their seal of approval earlier this month.

Transneft spokesman Sergei Grigoryev said if the Baltic system is expanded and the Nakhodka project goes ahead, no other pipelines would be needed.

"If the government gives the go-ahead to Nakhodka, there will be no need for the Murmansk pipeline at all," he said.

The oil barons are pushing their own pipelines purely out of self interest -- they want to set their own tariffs and avoid current laws limiting exports to 30 percent of total production, Grigoryev said.

"There would be complete anarchy [without the limits]," he said, because the domestic market would be left without oil.

Analysts said the showdown could have wide-ranging ramifications, but in the end, the oil barons would be forced to compromise. "This is a very important geopolitical issue for the government," said Pavel Kushnir, oil analyst at United Financial Group. "Its ownership of the pipeline network is an important lever of control over the oil barons."

If oil companies were allowed to have their own pipelines, it would set a huge precedent, Kushnir said. "The government would then not be able to insure that it keeps full ownership of the electricity grid and gas pipeline network in the course of reforming the natural monopolies."

"Extremely influential forces are lobbying these projects," said Valery Nesterov of Troika Dialog.

"This is too big politically for economic sense to rule."

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