Alice Friedemann’s book review of “Wheel of Fortune. The Battle for Oil and Power in Russia”, by Thane Gustafson. 2012.

The main thesis of this book is that Russia will collapse again. Soon.  Unless Russia drills offshore and in the Arctic with Western oil company help.  Western Siberian oil is declining.  Eastern Siberia doesn’t have much oil – just 800,000 barrels per day at most –and doesn’t have the required infrastructure of roads, pipelines, cities, towns, etc.

Gustafson is aware of how hard drilling in the arctic will be (though not the ecological consequences).  An ExxonMobil engineer he interviews about the issues of the Sakhalin Island area said that the “biggest challenge was moving ice.  The whole ice pack drifts along, and if you haven’t built for it, it will drag your whole platform away”.  Also, it gets to minus 60 degrees Fahrenheit, storms create waves over 30 feet high, there are frequent earthquakes, and most difficult of all is managing the thousands of skilled specialists from hundreds of contractors and subcontractors from all over the world.

Gustafson ultimately sees a new round of conflict for control and distribution of the oil revenue spoils, resulting in renationalization, sinking oil returns, and Russia sliding deeper and deeper into debt.  The only way he sees out of this is Arctic & offshore drilling, reducing welfare payments to citizens, more privatization, encouraging innovation and entrepreneurship, and other Capitalistic ideas.  Surely he realizes this isn’t likely given that he says the current Russian culture and political system “is based largely on a rejection of the 1990s, nostalgia for the Soviet empire, and resentment of the West”.

July 2013: Former Soviet Union peak oil and gas has excellent graphs of Russian oil and gas production and where their remaining reserves are.

Alice Friedemann   www.energyskeptic.com  author of “When Trucks Stop Running: Energy and the Future of Transportation”, 2015, Springer and “Crunch! Whole Grain Artisan Chips and Crackers”. Podcasts: Derrick Jensen, Practical Prepping, KunstlerCast 253, KunstlerCast278, Peak Prosperity , XX2 report ]

Why Russian Oil Production Will Decline in the Future

Vladimir Bogdanov, CEO of Surgutneftegaz speaking about his company (p 449)

• 60% of reserves have been produced already
• 75% of oil is from low-grade reserves
• 90% of what we produce is water
• Costs are rising twice as fast as world oil prices
• West Siberia, where two-thirds of Russian oil is produced, is declining

Energy Minister Shmatko (late 2010): By 2020 oil production likely to be down to 7.7 million barrels per day (10.1 million in 2010).

Mature fields are 80% of total oil production now (8 million barrels per day).  To offset 2% of decline in these large fields, the oil industry must add 160,000 barrels per day of new production to maintain current levels, or 1.6 million barrels per day by 2020 from poor quality, undeveloped fields at a cost of over $5 billion per year.  Another $20 billion per year is needed to keep the decline of the existing large oil fields from declining even more precipitously.  Over time, the absolute volume of decline will grow, and every new barrel will be more difficult and expensive.  In other words, by 2020 it would take $50 billion a year to produce the same amount of oil as now.

Gustafson is not very peak oil aware, the decline rate is much more likely to be over 8% from the largest fields, and he never mentions EROI.  He doesn’t have a clue about the peak oil situation.  On page 458 he writes that peak oil won’t happen until as early as midcentury or as late as well into the next century.

But he knows a hell of a lot about Russian oil – more than I wanted to know, the paraphrasing and direct quotes below are from the beginning and end of the book.

Today, Russia is even more dependent on oil revenues than before the crash. 

The renewed growth of oil production encouraged complacency and shortsighted greed. The inherited hydrocarbon wealth—already extensively explored and developed…came to be taken for granted by the political class and to some extent by the oil companies themselves, lessening the urgency of investing in new recourse of pursuing innovative approaches.  The legacy fields still held an abundance of recoverable oil, which could be produced by techniques that were not particularly advanced and quickly mastered by local operators.  The Russian oil industry in the 1990s had little need of the next-generation skills required for Arctic offshore projects or unconventional reservoirs, which would necessarily have involved foreign partners or service providers.

Therefore, over the long run, “Soviet legacy assets have acted as an anesthetic, delaying the adaptation of the Russian oil industry to modern management and technology.  The next generation of oil and gas will force the oil industry toward new oil that will be deeper, hotter (or colder), higher in pressure, more sour (more sulfur), more complex geologically, and more remote and therefore, far more costly.

There aren’t smaller, independent operators in Russia who can help make the transition to more difficult oil due to the vertical gigantism of the existing system.  Also, Russians are proud of their own practices and resist change or ideas from outside.  Above all, Russians are determined not to lose control or ownership of petroleum to outsiders.

Russian Culture hasn’t changed much

After the fall of the iron curtain, the vast majority of Russians resented the foreign ideas and new capitalism.  They continued to believe in a combination of Soviet Marxism and traditional Russian culture.  In the oil fields, the prevailing culture was the opposite of capitalism.  Workers were housed with electricity and water provided for a lifetime. The capitalistic Moscow newcomers were seen as likely to deplete the oil, and fire people like Western corporations. Old-timers like Siberian driller Vladimir Bogdanov were, and still are, revered in the oil towns.

“The Soviet system of totalitarian controls and systematic scarcity led Russians to form informal networks of collusion and exchange, to trade access, information, protection, and scarce goods.”  With no private property and extreme accumulation of private wealth criminal, the best strategy of an entrepreneur was to share or rish being attacked.  No one operated alone. “Networks of mutual trust were essential for survival…the norms of exchange and sharing—with neighbors, with partners, with political allies—have carried to the post-Soviet era. Yet in the absence of secure legal protections and property rights, these informal relations (which we call “corrupt” or “patrimonial”) continue to serve the same defensive functions as in Soviet times.   As a common Russian business saying goes, “Good friends are worth more than good contracts.”

“Many Russians see the 1990s as a disaster and a humiliation, a time of invasion by foreign powers, interests, brand names, and values”

Russian Political structure hasn’t changed much either

Most of the machinery of government survived at all levels, and especially regionally and locally.  Most of the energy sector remained under state control, though weaker in the 1990s.  The gas and electric industries especially remained within state control.  Although the oil industry broke free and became private, the state still owned the oil resources in the ground, the pipeline system, the borders, customs, and the power to control oil exports.  Although weakened in the 1990s, the state came rip-roaring back into power and control again later.

Effect of 2008 Recession: Another Crisis is Brewing

The optimism of the 2000s disappeared.  On the eve of the crash an oil price of $70 per barrel was enough to produce a surplus.

By 2012 it took nearly $120.

Capital flight resumed again after the crash at a higher rate than ever before.  Domestic investment lagged.   The political and business elite appeared to be gripped by a malaise over the future of the country, which Putin’s return to the presidency in 2012 did not dispel.

In 2008 oil production declined for the first time since the 1990s.  Although growth resumed again later, it was unbalanced since the increase came from only a few large new fields.  But the vast majority of the oilfields in West Siberia are entering a long-term decline.

The costs of finding and producing oil are rising rapidly yet the tax system takes 90% of the profits.  So with no incentive to invest in new fields or technology, new drilling and exploration isn’t happening much.

The state economy and welfare system depend on oil revenues, need increasing amounts of oil revenues, at the same time that oil industry costs and income are declining.

This is a threat to the entire Russian political and social system.  Right now the system benefits from the legacy oil investments and the “windfall” profits from the rise of world oil prices – an external factor that Russia does not control (which the author calls “rents”).  Russia has depended on legacy and windfall profits for 20 years that may not be able to continue in the future.

“A flow of rents inevitably attracts rival claimants.  The story of the post-Soviet oil industry is largely that of the battle for rents—in the 1990s for the legacy rents and in the 2000s for the global windfall rents.  By the end of the first decade of the 2000s, the state had succeeded in recapturing the lion’s share of both.”  Now a large part of the political and economic system depends on oil rents.

Unless the industry is able to recapture some of the state’s share for its own needs, it will underinvest, and oil production will eventually decline.  At the end of the road lies renationalization, but even that would not be more than a stopgap, since the fundamental problem is the shrinking of margins.

“The coming decline in the flow of surplus from oil attacks the entire rent-based system and is already raising the level of conflict.  Several categories of what in the West would be thought of as costs are actually key parts of the rent-distribution system.  Russianoil and gas companies pay taxes to the state, but they also pay informal “taxes,” in the form of bribes and “social payments” to localities (known to Russians as sotsialka).  Production costs are inflated, since much of their equipment and services is purchased through networks of connected companies.  The process is subterranean, nontransparent, and largely invisible to outsiders, but it is a major channel of rents.”

“This flow is vital to the maintenance of the economy and the political system.  Rent dependence is not simply at the heart of the system; it IS the heart of the system.  The obvious implication is that if the flow of petroleum rents were ever to slacken, Russia would be deeply destabilized.”

“When he came to power, Putin saw his prime mission the restoration of stable central power.  But Putin has been unable to build a stable institutional or ideological mechanism to ensure governability over the longer term.  The system is based largely on a rejection of the 1990s, nostalgia for the Soviet empire, and resentment of the West.  That is weak glue. What remains is elite self-interest.  The result has been a spread of corruption and interclan wars, and, through the selective application of state power, a takeover of the “commanding heights” of the economy by politically favored interests.  The oil industry has been one of the sectors most affected.  The determination of state players to control the industry and to capture the bulk of its revenues has deprived it of the resources needed to renew itself and weakened its incentive to continue modernizing.”