Future of Russian Energy Exports

Dr. von Hirschhausen argued that the development of Russian energy exports is not driven by geopolitical considerations, as many believe; instead they correspond to companies' strategies of profit-maximization. This pattern of "the flag following the trade" can be observed, he suggested, in each of the three energy sectors-electrical power, oil, and gas-and across all regions where Russian firms play a key role, from European Russia to the Caspian (the subjects of his talk) to Asia.

Geopolitics do, however, figure into decision-making regarding the routes and means by which Russia, the exporting country, delivers its oil to Western European importers. Between these two parties, "transiting countries" Belarus and Ukraine are quite significant, and any sort of coalition among all four parties would be even more influential.

Though often overshadowed by oil and gas, the Russian electric power sector is an important exporter and not solely oriented to domestic consumption. After the ruble devaluation in 1998, producers of electricity have held a comparative advantage in production, though exports remain low. Increased pressure to export has spurred an alliance between RAO EES, the owner of the grid infrastructure, and the nuclear power producers who maintain low generation costs. Hirschhausen expected that two planned electricity export projects, the Ukrainian power bridge to CENTREL and the Baltic Ring between Lithuania and Poland, are unlikely to be successful simply due to capacity constraints on transmission. These projects lack the converter stations necessary to transfer the energy westward to Europe.

For both oil and gas, declining domestic consumption over the past decade has allowed export expansion. Since 1991, oil exports to non-CIS countries have increased from 50 to 100 million tons annually in a precisely inverse relationship with the decline in exports to CIS countries. Russian companies, he explained, are diversifying their resource base, integrating downstream as majority or minority shareholders in refineries throughout Eastern and Central Europe, and they have begun to enter the retail market.

In the Caspian Sea Region, according to Hirschhausen, large pipeline projects will not be realized in the way in which they were planned in the early 1990s because those plans are not profitable. Oil production is increasing only incrementally and Kazakhstan remains the region's only significant exporter. Turkmenistan, Azerbaijan, and Uzbekistan have yet to live up to the industry's expectations. If one tempers hope with reality, Hirschhausen suggested, it becomes clear that a significant expansion of output and exports is unlikely. With the recent completion of the CPC and Odessa-Brody pipelines, no new pipeline capacity is required in the medium term-including Baku-Ceyhan, a project not likely to provide a return on companies' investment in it, in Hirschhausen's estimation, though this point was hotly debated by several seminar participants.

Compared with oil, the drop in natural gas output has been less extreme, though Russia's known reserves are finite and will decrease dramatically over the next ten years or so. Major investment is needed to identify and develop new gas resources. Today, however, Russian gas is competitive on the Western European market, and the fate of the industry will depend on export revenues, Hirschhausen stated. Export strategy will not be affected by structural reforms, should they occur, nor does the position of individual companies like Gazprom or Itera have great impact on exports.

Until recently, Russia's heavy dependence on Ukraine as a gas transit country has resulted in Ukraine's abuse of their monopoly status to charge monopoly rents. Russia has now found three potential alternatives to the Ukrainian routes: "Blue Stream" through the Balkans and Turkey to the south; "Northern Lights" through Belarus to Poland and Germany; and the Kobrin/Kondratki bypass around Ukrainian territory.

Hirschhausen shared with the group a simulation analysis of potential effects of pipeline expansion which indicates that three parties-Russia, Belarus, and Western Europe-could realize mutual gains from the formation of a Russian-Ukrainian-Belarusian exporting cartel. (Several members of the audience challenged the underlying assumptions of his model.) Only Ukraine would suffer revenue losses, but could remedy that through cooperating with Belarus in the northern coalition. Through the cartel, export quantities would rise, about 15-30%, he proposed, lowering prices significantly for Western European importers. Despite the loss of its transit monopoly, Ukraine would-and does-remain a cornerstone of Russia's energy export strategy.

Questions and Discussion

Asked repeatedly why he thought oil companies are not serious about Baku-Ceyhan, he responded that Baku-Ceyhan, like Blue Stream (often referred to as "Blue Dream," he noted), is unrealistic, because though Turkey's demand for energy is increasing, it is in "tough shape" economically.

Pressed for a further explanation of why he thought Caspian oil would not be brought to market through Baku-Ceyhan, he reiterated that one cannot perfectly forecast future energy prices. Yet it seemed quite clear to him that after the enormous expense incurred by putting oil in obsolete infrastructure and transporting it through mountainous terrain, AIOC would be unable to reap a profit if prices were below $30/barrel. He admitted, though, that Kashagan is "a huge find," so huge perhaps that the immense construction costs are acceptable. Nonetheless, Western companies have no need for the few million tons of oil coming from the Caspian when they can invest in more lucrative projects in Venezuela, in the North Sea, or in North Africa. Hirschhausen quoted an 18th century emissary to Catherine the Great who said that Caspian oil is "good for nothing, except to grease a few wheels."

As to whether Russian oil companies collude against Western companies' interests in the Caspian, Hirschhausen agreed with the questioner that Caspian exports are indeed "determined by Russian companies," but that the interrelationship of Russian companies is irrelevant for the price or quantity of Russian exports because it simply boils down to internal rent-seeking.

Hirschhausen's model incorporated no simulation of uncertainty, one audience member noted. What would be the effect of increased military activity in Chechnya, and perhaps in the future, in Afghanistan? Hirschhausen responded that due to instability in the region, Caspian states (with the possible exception of Kazakhstan, whose northern territories are Russian-controlled) will not be "reliable oil producers" for fifty years.

On the subject of Russian energy exports to the east, to Asia, Hirschhausen believed that gas exports will remain minimal while oil exports to the region might increase since oil is more easily transported. Presently China powers its western provinces with Szechuan gas reserves (the eastern provinces do not use gas), and Japan is content to import from the Persian Gulf.

Anders Åslund thanked the speaker and closed the session highlighting four main points from the meeting: companies' profit-maximizing behavior, monopoly effects in the industry, the role of the region's uncertain political situation, and that no one knows what energy prices will be in the future, "and that will determine a lot."