#10 - JRL 7237
Moscow Times
June 24, 2003
Nicely Stuck Between Two Oil Foes
By Valeria Korchagina
Staff Writer

For over a decade Russia has searched for an instrument to regain its influence in world politics. And now it seems to have found it -- it is oil.

The demand for crude oil is now forcing major developed countries to seek good relations with Russia, the world's second-largest producer. In the clash between the West, particularly the United States, and the Organization of the Petroleum Exporting Countries over stable crude oil supplies, everyone wants to be Russia's friend.

A number of U.S. officials have argued in past months that Russia should boost its oil output to gain a more prominent role on the market and that Russian crude is welcomed by American consumers.

OPEC, too, is showing growing interest in Russia, issuing open invitations for Russia to join the 11-nation cartel. Just this month, Russia for the first time participated in an OPEC meeting as an observer.

But as consumers push Russia to boost production and OPEC pushes Russia to play by its quota rules, all Russia has to do to preserve its newly acquired importance is literally nothing. It has to not side with either consumers or suppliers.

This is mainly a question of diplomacy, since Russia is not in a position to take sides anyway. A price-taker by nature, unlike No. 1 producer Saudi Arabia, Russia is poorly equipped for quick output alterations. Asking Russia either to dramatically boost output to suit consumers or cut it to please OPEC is pointless at least for a few more years. In the meantime, Russia is well positioned to gorge itself on petrodollars and think what it should do in the future.

Created in 1960, OPEC grew into a force to be reckoned with on the world oil market, particularly after it agreed in the mid-1980s to guarantee steady oil supplies at an acceptable price ($18 per barrel on average). The successful operation of the mechanism was secured by Saudi Arabia's role as swinger, its willingness, when necessary, to cover for short-term supply interruptions caused by anything from political disagreements between other cartel members and the main consumers, wars or even unusually cold winters in the United States.

But the sweet deal between the world's largest producer and U.S. consumers seems to be souring. As a result, the United States has turned its attention to other oil-producing regions to ensure alternative flows to the market should Saudi Arabia fail to fulfill its role as OPEC's swinger.

"There is growing irritation within the U.S. administration with Saudi Arabia," said Alexei Malashenko, a political analyst with the Carnegie Moscow Center. "They are annoyed with Saudi Arabia for becoming less devoted to the United States, with the fact that terrorism often takes routes from Saudi Arabia and an occasional Saudi-bred 'bin Laden' pops up here and there."

Saudi Arabia's rulers are under pressure from within OPEC and from within their own kingdom.

Saudi Arabia's leading role in OPEC began to weaken after the first Gulf War in 1991. The second U.S.-led military campaign in Iraq further reduced Saudi influence on other, primarily Islamic members of the cartel, who are less inclined to be friendly with the United States or, like Iran, see the United States as an enemy.

Additionally, the internal political situation in the kingdom of 22 million people, which lives almost entirely on oil revenues, is deteriorating. Public discontent with budget policies seen as slighting the average citizen while the lion's share of oil revenues is channeled to the extended royal family feeds the growth of radical Islamic movements.

"The authorities are trying really hard to control the situation," Malashenko said. "They have jailed radical imams in the hundreds and introduced strict censorship. But as with any extremist movements, it works like a spring -- you can press it down but it will fire back as soon as an opportunity arises."

The internal and external political factors combine to prevent Saudi Arabia from being as friendly with the United States as it might otherwise be. For example, in the buildup to the U.S. military operation in Iraq early this year, the Saudi leadership denied the United States the use of Saudi air bases, as this would be too unpopular to handle both within the kingdom and in the region in general. Hence the irritation from the U.S. side.

Looming Oil Deficit

And yet, as OPEC becomes less and less reliable for consumers, its influence on the market continues to grow for the simple reason that in most non-OPEC oil-producing regions worldwide deposits are drying out.

The world's current daily demand hovers at around 75 million barrels. About 40 million of the total volume is oil that needs to be purchased from the major oil producers. About 27 million barrels of the oil supplied to the market comes from OPEC. The United States' keen interest in the game is based on the fact that out of the total 75 million barrels of daily global consumption, a whopping 20 million barrels are eaten up by the U.S. economy, with 60 percent of this oil burned in the engines of American automobiles.

With OPEC's control of the market already huge, by 2010 the situation will develop even more radically in favor of the cartel, said Chris Weafer, chief strategist at Alfa Bank.

With global demand for oil expected to reach 90 million bpd, at least 70 million barrels will be oil purchased on the market from foreign producers, Weafer said. OPEC's share at that moment will likely be 50 million bpd, making all developed economies even more dependent on the cartel's behavior.

And this is precisely the situation a major consumer like the United States wants to avoid. Thus its interest in reviving Iraqi oil production, its increased attention to barely tapped Caspian hydrocarbon deposits and friendly approach to Russia.

"So the U.S. is pursuing a goal of building up a buffer that can protect the market in the case of supply shortages. And it's done by encouraging Russia to grow production and restoring production in Iraq as quickly as possible," Weafer said.

Of course, producers like Russia or Iraq, or the numerous nations that have access to the Caspian Sea region deposits, would never be able to replace OPEC, or even become serious competition to the cartel. But the aggregated potential output capacity of all of them could cover a temporary shortage.

"And it is the short-term shortages that are a real threat to economies," Weafer said, adding that even if Saudi Arabia were at some point to turn into an Islamic republic, oil production would still have to resume, since oil is the only source of income for the country. "Stopping production for a long time would be simply suicidal," he said.

A 2-Year Lag

The United States is rushing to get Iraq's oil production up to full capacity of 3 million barrels per day, but this will take time, at least two years. And this gives OPEC a chance to win back the loyalty of its customers.

Russia in the meantime can relax and take time to figure out what it should do. In any case, at the moment it has little power to raise exports because of the limited capacity of existing routes -- mainly ports and pipelines.

Russia's oil majors have long campaigned for construction of more pipelines that could allow them to boost exports. The state, which controls all but the Caspian Pipeline System with a designed capacity of 560,000 bpd, however, has taken a cautious approach.

In 2002, Russia exported about 3.5 million barrels per day, and this year exports are expected to hit about 4 million bpd. By the end of 2005, providing the Baltic Pipeline System's throughput is expanded from the current 240,000 bpd to 840,000 bpd and the Yukos-backed Russia-China pipeline is built, Russia will be able to export just under 4.5 million bpd.

Further projects to expand export capacity and allow Russia to increase its presence on the world market, including a pipeline from western Siberia to Murmansk, have barely moved beyond the discussion stage.

To Pump or Not to Pump

But if Russia does resolve the export pipeline bottleneck problem, a fundamental economic question must still be answered: Should Russia try to boost production and exports to maximum levels?

As the world pays big money to purchase oil on the market, Russians, whose domestic oil market is closed and regulated, still buy oil at $5 per barrel -- all thanks to the fact that current export levels are locked in by the limited export capacity.

"But if the pipelines match the export demand, it will soon lead to an equalization of domestic prices with international prices," said Pavel Kushnir, oil and gas analyst with United Financial Group.

"The question is whether Russia needs domestic oil prices to be equal to world market prices," Kushnir said.

According to Kushnir, with abundant export capacity there would be a window of opportunity to simply buy oil domestically and resell it abroad, for as long as prices differ. Soon enough, though, the gap would close, forcing domestic consumers to pay international prices.

Another potential problem is oversupply to the market, which would ultimately end the current run of high oil revenues. In this case, Russia would indeed need to think again about becoming OPEC's ally.

"The test will come if prices go from the high $20s to the low $20s or lower," said Edward Chow, a visiting scholar at the Carnegie Endowment for International Peace in Washington, who specializes in energy issues. In this case, Russia would have to decide whether it would want to support OPEC's actions aimed at propping up the price, he said.

So far, Russia has avoided doing so. Even when it formally agreed to OPEC's demand and promised to cut output by 150,000 bpd in the fall of 2001, the pledge proved to be nothing more than lip service, since output actually grew in this period.

But for now, there is no rush for Russia to make any decisions.

To keep its sweet position between the United States and OPEC, all Russia has to do is not take sides publicly, Weafer said.