Source: Testimony before the U. S. Senate
United States Energy Security: Russia and the Caspian
Testimony before the U. S. Senate, Committee on Foreign Relations
April 30, 2003
Edward C. Chow, Visiting Scholar, Russian and Eurasian Program
It is my honor to appear before your subcommittee to discuss the role for Russian and Caspian oil in U.S. energy security. I joined the Carnegie Endowment for International Peace in Washington only this year to focus on international energy policy. However, my views on the subject are informed by 25 years of experience in the international oil and gas industry, primarily with a major American oil company.
In recent years I've also advised foreign governments and western companies on strategy, investment policy and negotiations in the oil and gas sector, particularly in the former Soviet Union. I hope to bring my industry perspective from work not only in this part of the world but also Latin America, West Africa, the Middle East, east Asia and western Europe to your committee's discussion on this important subject for U.S. energy security. No one can argue with the proposition that it is important for policy makers to have a realistic view of the policy environment. Otherwise political expectations are likely to be inflated and policy misguided. On the subject of oil and gas in the former Soviet Union, it is therefore particularly distressing to see the volume of misinformation and hyperbole, not only from governments and industry in the region which may have a vested interest in exaggerating the significance, but occasionally from our own government.
A number of years ago most of us in the industry were shocked to find a State Department report to Congress discussing the possibility of close to 200 billion barrels of crude oil reserves in the Caspian at a time when industry estimates were at best 10 percent of that level. I was glad to hear Len Coburn today give a more measured estimate of 17 to 33 billion barrels.
SEN. HAGEL: He is sitting right behind you, so he'll be very pleased to hear that.
MR. CHOW: But 30 billion barrels of crude oil reserves is still barely only three percent of total world proven reserves. The fact remains that there has been only one significant discovery in the Caspian since the fall of the Soviet Union. In a global context, the Caspian represents another North Sea or Alaska, it is significant but even full development would not represent a fundamental shift in oil market dynamics or the world supply picture. It is one thing for the president of Azerbaijan to boast about his country signing the contract of the century, quite another for U.S. officials to repeat this preposterous claim.
Worse still, if U.S. policy is based on mistaken expectations and lack of understanding of petroleum industry realities. In testimony today, as well as that before this committee earlier this month, the State Department referred to Caspian Basin production of 1.6 million barrels per day of 2001, and the possibility of 5 million barrels per day in 2010. Most of us in the industry would have a hard time finding production in 2000 to be much more than half of that level in what can be called the Caspian Basin, and believe that we will be doing well if production can be raised to 2 million barrels per day by 2010.
Industry expectations are moderated not only by geological risks, but by significant technical, economic and political risks and all development in the region. Major finds are challenged by either being offshore or in deep high pressure reservoirs, or with sulfur-laden associated gas that needs to be processed and the sulfur removed, all far away from market in a landlocked location. Often times, all of the above. Investments required are measured in billions or tens of billions dollars.
Peaceful political succession is unproven in the region, political legitimacy of the governments in the region, as seen by their own population, has declined since independence from the Soviet Union. At the same time the investment climate, which was largely welcoming a decade ago, has deteriorated with tougher contract terms, concerns over sanctity of contract and greater appetite on the part of ruling elites for event (ph) seeking opportunities.
The increase or income has coincided with more autocratic rule, enhanced the rulers' ability to temporarily pay off parts of the elite by sharing some of this wealth, and allowed deferral of desperately needed fundamental economic and political reforms. These unfortunate but often repeated developments associated with sudden oil income have in the past led to political instability, for example in Latin America and West Africa. No wonder oil folks around the world believe all the easy oil has been found and produced a long time ago.
More importantly, if uncorrected, this troubling trend in the Caspian region can give rise to longer term threats to U.S. security interests beyond energy. Turning now to Russia, most of the commentary on the remarkable increase in Russian exports in the last two or three years has missed the fact that this has not been due to new discoveries or even development of new oil provinces or new fields. Russian oil production is around eight million barrels per day today. It was over 10 million barrels per day at peak Soviet oil production reached in the late 1980s. So the rise in exports which has been dramatic is driven by the revival of Russian production in the last three years, but more importantly by the total collapse of Russian oil demand following a similar collapse in its economy since the fall of the Soviet Union.
Russian oil consumption dropped from five million barrels per day in 1991 to two and a half million barrels per day today, accounting for almost all of the export surge. This oil consumption level can be compared with the United States, where we consume 20 million barrels per day. This in a country with approximately half our population and greater transportation distances with twice the number of time zones than we have.
The short-term causes of the recovery of Russian oil production are ruble devaluation after the 1998 financial collapse, improving the cost structure of the Russian petroleum industry, the return of domestic investment in the sector after owners of privatized oil companies believed their property rights would be largely honored by the Russian state, and the introduction of Western technology by using international service contractors in modern oilfield practices and reservoir management.
Can Russian oil production increases be sustained without more fundamental structural changes in the sector, including those reforms required to attract investment not only from domestic sources but internationally? With the sole exception of Sakhalin, neither the Russian government nor Russian industry has been particularly welcoming to direct foreign investment in the oil and gas sector, in spite of the public rhetoric. Government fears loss of control and industry naturally wants to avoid competition. Having achieved production and export growth by encouraging domestic investment, the Russian government seems to be hesitant to pursue further restructuring in the oil and gas sector. Reform of Gazprom, the natural gas monopoly, and Transneft, the state pipeline monopoly is hardly even mentioned anymore. Both are significant obstacles to investment, even by Russian oil companies.
Production sharing agreements, or PSA, legislation called for by international oil companies wishing to invest in Russia has been rejected for almost all projects other than for frontier exploration.
It remains to be seen whether this trend of stall in reform will be maintained after the coming round of Duma and presidential elections. Before further reform can take place there needs to be a healthy political debate in Russia on the role the oil and gas sector should play in its overall economy, and the impact on its politics, domestic and foreign policy.
Given its population of 130 million people, industrial base and agricultural potential, it is questionable whether its economy should be based on maximizing oil and gas exports, potentially crowding out all other economic activity. The oil industry is capital, not labor intensive. It demands centralization of decision making, both politically and economically in a few hands.
Of course the suits, the interest of current political and business leaders is less clear whether this benefits the Russian people overall. What is clear is that with 5 percent of the world's known oil reserves and a reserve production ratio of around 20 years, Russia will always be a price taker in an oil market dominated by OPEC, not a price setter.
Our own view of the role Russia can play in U.S. energy security should also be informed by this reality. Russian and Caspian oil development may be prospective and lucrative to individual countries or oil companies, but nothing that is happening there would challenge the fact that two-thirds of known oil reserves are in the Persian Gulf. Certainly diversity of supply is important to the world oil market and benefits the United States as the largest oil importer in the world.
So new supplies from Russia and the Caspian are significant, just as new supplies from Deepwater Gulf of Mexico, Deepwater West Africa, synthetic crudes from Canada and Venezuela, under-explored Anchorage in Alaska, bringing Alaskan and Canadian arctic gas to the lower 48s, new LNG projects, gas to liquids conversion technology, all these sources are important. Not to mention conservation and energy efficiency improvements.
These sources, diversity of supply sources are important because they stretch the time when the last incremental barrel of oil demand must be satisfied by the Persian Gulf. However, we should be under no illusion that a major supply disruption of prolonged duration in the Middle East can be replaced by such sources. Giving their position as the world's swing producers, with the most abundant and cheapest oil to produce, sitting between major oil markets in Europe and the United States and rapidly rising demand in Asia, Persian Gulf countries have a unique and irreplaceable position in the oil supply chain.
Until a technological leap allows us to move beyond oil's dominance in world energy consumption, a major supply disruption of prolonged duration in the Middle East will have a direct impact on U.S. energy supply and pricing, whether or not we are importing a drop of Persian Gulf oil ourselves. Oil is a largely fungible commodity in a fast moving global market, as Julie has pointed out, and supply will shift according to market signals. We and other members of the International Energy Agency are also under treaty obligations not only to hold strategic stockpiles but also share those stockpiles in times of supply crises.
Any policy on international energy security based on bilateral oil relationships with other countries is therefore unlikely to be effective. U.S. policy must be based on a realistic assessment of the global energy situation and the potential role these countries can play, not based on unrealistic expectations or as a substitute for well balance foreign policy in the region.
By focusing too much on energy relationships we give these countries the impression that this is all we care about. By explicitly discussing specific projects like individual pipelines or laws that favor -- that we favor, like PSA legislations, we give the impression that we care less about improvement and fundamental conditions, like the rules of law, transparency and more political openness. These are the conditions that will lead to a better investment climate for domestic as well as foreign investors, not just in the export oriented national resource center, but in the larger economy where the population lives.
They hear our rhetoric but do not believe us when our government keeps pushing project. Leave that to industry and companies. Government officials should focus on what they know and can impact, which is how to foster a business climate conducive to investment and to avoid market distortions. Better that U.S. officials discuss lessons we learned in sectoral reform from our own deregulation of the oil and natural gas industries than to lecture the Russian Duma of what laws they should pass.
I am very sympathetic to the extremely difficult job U.S. officials have to perform in this part of the world, having traveled there on a regular basis since 1992. However, we cannot reinforce the rulers and the general population's belief the U.S. cares only about oil and the war against terrorism, without having to face long term the unintended consequences of such a policy.
Russia, Central Asia and the Caucasus are important to U.S. foreign policy interests whether these countries have any oil or not. We should not allow exaggerated expectations in one area for them and for us to detract from sound overall policy. Thank you.
