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#11 - JRL 7223
June 15, 2003
Could Iraq Pose Threat to Russian Economy?

It is no secret that our economy is dependent on the dynamic of oil prices, but that dependency is growing. The Soviet Union produced more than 500 million tonnes of oil and exported 132-135 million tonnes, while Russia produces only 400 million tonnes of oil annually but exports two times as much - 275 million tonnes. At the present time, oil exports account for one third of Russia's GDP and a drop of USD 1 in oil prices means a loss of USD 1 billion in the government budget.

Therefore, it is not surprising that one of the chief goals of our national security has become the support of world oil prices. One of the main reasons for Russia's default in 1998 was the fact that the US and Saudi Arabia successfully agreed to lower the price of oil. Moreover, most specialists agree that one of the major reasons for the US-led invasion of Iraq was to control the price of oil and the cost of energy resources. Under US control the new Iraqi administration is planning to begin exporting oil once again. By the middle of June, Baghdad is planning to export 1.5 million barrels of oil per day. The new Iraqi Oil Minister Tamer Gazban says that the country should have no problem reaching pre-war oil export levels of 2-2.5 million barrels of oil per day by the end of the year.

According to several reports, during the UN sanctions Iraq regularly violated the embargo on oil exports. Witnesses confirm that automobile caravans carrying oil regularly left the Northern part of the country for Turkey where the oil was delivered and refined. Therefore, when Gazban talks about the sharp increase in oil exports he is merely confirming the legalization of long-time established practices and good channels of oil exports.

At the present time it is difficult to say how much the Iraqi oil barons are prepared to share with the central power. However, there should be no problems with their legalized emergence on the world oil market which will be controlled by the Kurds who are currently allied with the US.

If the market bears out that Iraq is able to quickly increase its exports of oil, and OPEC will take a decision favorable to the US, which is very likely in the current political situation, oil prices will begin to drop. But more importantly, the story could end sadly for Russian oil production.

Recent research was presented at a session of the bureau of the Russian union of industrialists and businesspeople which was conducted for large oil companies and determined the effectiveness of their work independent of world oil prices. It turns out that Yukos and Sibneft will be able to endure a drop in world oil prices to USD 9 per barrel of oil, while Lukoil, Rosneft and TNK can endure a drop to USD 12, Surgutneftgaz to USD 13.5 and Tatneft to USD 16.

Moreover, the majority of small oil companies will begin operating at a loss if the world price of oil drops below USD 20 per barrel. In comparison, the prime cost of Iraqi oil is valued at USD 1-1.5 per barrel, Saudi Arabian oil USD 2 and Oman oil USD 5. Meanwhile, the minimal price level of a barrel of oil from the Urals is USD 15-16. Of course, such a state of affairs would deprive Russian oil production of its profitability but allow it to pay for the cost of its production. Any further drop in world oil prices would leave Russian oil uncompetitive.

In spite of the fact that Russian oil companies have achieved great success in lowering the prime cost of oil extraction, the world market dynamic is very complicated and further increases in the volume of extraction will require large investment. Already in two or three years, it will be necessary to invest in new oil fields at a cost of USD 30-32 billion per year in order to maintain the planned levels of oil extraction. In the worst case scenario, according to data from the Ministry of Natural Resources, national oil reserves are sufficient only until 2010.

However, Russia will soon have a chance to defend its oil interests in the international arena. In the Qatar capital of Doha in mid-June, OPEC is planning to discuss at a conference the question of Iraq's return to the world oil market. Moreover, representatives of non-OPEC oil producing countries, including Russia, Norway, Mexico, Oman, Angola, Egypt and Syria, are invited to attend.

The decisions OPEC will take at the conference are completely predictable. It will work toward lowering the quota on oil extraction in order to compensate for the possible reestablishment of Iraqi oil exports. However, the effect of such a decision by OPEC in contemporary conditions could be very limited. At the present time the current state of affairs exists: OPEC needs to lower the volume of oil deliveries to support oil prices, and at the same time independent producers including Russia and Mexico will increase their levels of oil extraction, taking a share of the market from OPEC and correspondingly limiting its efforts to support the current price of oil.

Over the short-term, OPEC measures for regulating the level of output could influence the market price and prices will not fall. However, oil exporters and consumers are especially interested in the long-term effects of such decisions. The long-term perspective will be significantly influenced by how well the US-led coalition can keep the peace in Iraq. Without a stable and secure peace in Iraq, it will be impossible to attract investment into the oil infrastructure.

This week the price of a barrel of oil jumped to USD 30.5 as the market reacted to information that the development of Western oil companies in Iraq has been put off for an undetermined amount of time. Moreover, the prices for insuring businesses in Iraq have skyrocketed and conducting oil excavation is considered unprofitable.

Under these conditions, the Pentagon stated that it is not possible for the time being to provide security in Iraq for foreign specialists and called on companies operating in Iraq to take private security measures.

In this climate, the majority of specialists have serious doubts about the optimistic prognosis of growth in the extraction of Iraqi oil. The fact that the oil extraction industry in Iraq has used out-dated technology for several years and requires large investment in the USD billions is another reason specialists have doubts. Time and peace are required in order to attract this investment. The influx of Iraqi oil, which can indeed influence world prices, will not be possible earlier than next year. Therefore, Russia still has time to take appropriate measures in order to protect its budget from an oil default.

Written by Alexey Frolov, St. Petersburg Translated by Richard Sleder

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