Article View

Help

Interface language:
: 0 articles English

Databases selected: ABI/INFORM Dateline, ABI/INFORM Global, ABI/INFORM Trade & Industry What's New

Article View « Back to Results Article 1 Publisher Information

Mark Article Abstract , Full Text

The Battle for Energy Dominance

Edward L. Morse and James Richard. Foreign Affairs. New York: Mar/Apr 2002.Vol.81, Iss. 2; pg. 16

» Jump to full text

» Translate article into: Spanish , Portuguese

Subjects:
Classification Codes 8510 Petroleum industry, 9176 Eastern Europe, 9178 Middle East, 9190 United States, 1210 Politics & political behavior
Locations: United States, US, Russia, Saudi Arabia
Author(s): Edward L. Morse and James Richard
Article types: Commentary
Publication title: Foreign Affairs. New York: Mar/Apr 2002. Vol. 81, Iss. 2; pg. 16
Source Type: Periodical
ISSN/ISBN: 00157120
ProQuest document ID: 107399221
Text Word Count 5751
Article URL: http://gateway.proquest.com/openurl?url_ver=Z39.88-
2004&res_dat=xri:pqd&rft_val_fmt=info:ofi/fmt:kev:mtx:journal&genre=article&rft_dat=xri:pqd:did=000000107399221&svc_dat=xri:pqil:fmt=text&req_dat=xri:pqil:pq_clntid=28949

More Like This »Show Options for finding similar articles

Abstract (Article Summary)

The American campaign against terrorism may be grabbing the headlines, but another battle is being waged with perhaps equally significant long-term implications: the contest for energy
dominance between the world's two largest oil exporters, Saudi Arabia and Russia. This battle will have fundamental consequences for the world's economy, U.S. energy security, Russia's
global role, the future relevance of Saudi Arabia, and the clout of the Organization of Petroleum Exporting Countries. Thanks to the potential growth of Asian and U.S. demand, there could
be room in the future for both Saudi and Russian producers to gain market share if they cooperate. But it is more likely that the policies pursued by Moscow and by Washington will
restructure the battlefield.

Full Text (5751 words)

http://proquest.umi.com/pqdweb?index=11&did=000000107399221&S...PROD&VType=PQD&RQT=309&VName=PQD&TS=1090836004&clientId=28949 (1 of 8) [7/26/2004 3:31:09 PM]

Article View
(Copyright 2002 by the Council on Foreign Relations, Inc. All rightsreserved.)

Article Type: Essay

The Battle for Energy Dominance

Edward L. Morse and James Richard

russia vs. saudi arabia

The American campaign against terrorism may be grabbing the headlines, but another battle is being waged with perhaps equally significant long-term implications: the contest for energy
dominance between the world's two largest oil exporters, Saudi Arabia and Russia. This battle will have fundamental consequences for the world's economy, U.S. energy security, Russia's
global role, the future relevance of Saudi Arabia, and the clout of the Organization of Petroleum Exporting Countries (OPEC).

The contest emerged suddenly and unexpectedly. For each of the past two years, Russia has quietly but persistently increased its annual oil output at a rate of nearly half a million barrels a
day (mbd) -- the largest single increment of increased output of any country in the world. With the world economy and world oil demand stagnating, Saudi Arabia and its OPEC partners
therefore opted to reduce their output by 3.5 mbd. Then, on January 1, 2002, OPEC cut output by another 1.5 mbd to stave off a price collapse. Even though Moscow made a symbolic cut
in output as well, OPEC has not welcomed Russia's gain at the cartel's expense.

Russia and the Soviet successor states can easily continue to increase oil output at this rate for years to come. The victims of that increase, in all likelihood, will be Saudi Arabia, Kuwait,
and other oil producers with state monopoly companies that disallow foreign investment. The only oil not threatened by Russia's rise is the petroleum developed by international companies
outside of the key OPEC countries of the Middle East.

The Russian increases have come as a surprise, especially for OPEC. As recently as 1996, oil output from the post-Soviet states amounted to barely 7 mbd. Many people forgot that
Moscow's state- owned enterprises once produced more than 12.5 mbd before the Soviet collapse -- the largest amount of oil ever produced by a single country, representing one-fifth of
global production. That sum is one- third more than Saudi Arabia's peak share at the end of 2000.

After undergoing tremendous transformation since the fall of the Soviet Union, Russia's firms have arrived on the world stage. Although vast room for improvement remains, Russia's oil
leaders have largely transcended their robber-baron days. Backed by improved rule of law, they are seeking to protect their new wealth and meet the performance criteria dictated by the
financial markets, especially because their firms' shares are now publicly offered. As a result, they are beginning to reinvest capital at a rapid rate. Thanks to them, Moscow is poised to
assume a far more significant position in the world petroleum sector than ever before.

Russia's oil revival has coincided with a downturn in the global economy and the first major reduction in the global demand for oil since the early 1980s. The nearly 1 mbd increase in its
production over the last two years came at a time when OPEC cut output, thus losing market share, to put a floor under prices. Not surprisingly, Moscow's motivations are being questioned
and are often seen as an attempt to grab power in the global arena. But Russia's petroleum revival has also coincided with the terrorist attacks of September 11, which have provided
Moscow a chance to displace OPEC as the key energy supplier to the West. Moscow's political leaders, as well as its corporate leaders in oil and gas, are portraying Russia's oil firms as
stable sources of supply, willing to add output to the market to keep prices reasonable and thus revive the global economy. In the eyes of these leaders, the new geopolitics of energy can
help Moscow gain both economically and politically. In economic terms, energy production lets Russia integrate itself into the industrialized West. In political terms, energy resources can be
used to buttress Moscow's goal of becoming a key partner of the United States.

king of the hill

Even before September 11, concerns had been raised over American reliance on Middle East oil. Global oil demand has been increasing by between 1.5 and 2 mbd each year, a rate of
growth with alarming long- term consequences. The U.S. Department of Energy and the International Energy Agency both project that global oil demand could grow from the current 77
mbd to 120 mbd in 20 years, driven by the United States and the emerging markets of South and East Asia. The agencies assume that most of the supply required to meet this demand
must come from OPEC, whose production is expected to jump from 28 mbd in 1998 to 60 mbd in 2020. Virtually all of this increase would come from the Middle East, especially Saudi
Arabia.

http://proquest.umi.com/pqdweb?index=11&did=000000107399221&S...PROD&VType=PQD&RQT=309&VName=PQD&TS=1090836004&clientId=28949 (2 of 8) [7/26/2004 3:31:09 PM]

Article View
A simple fact explains this conclusion: 63 percent of the world's proven oil reserves are in the Middle East, 25 percent (or 261 billion barrels) in Saudi Arabia alone. As the largest single
resource holder, Saudi Arabia has a unique petroleum policy that is designed to maximize the benefit of holding so much of the world's oil supply. Saudi Arabia's goal is to assure that oil's
role in the international economy is maintained as long as possible. Hence Saudi policy has always denounced efforts by industrialized countries to wean themselves from oil dependence,
whether through tax policy or regulation.

Saudi strategy focuses on three different political arenas. The first involves the ties between the Saudi kingdom and other OPEC countries. The second concerns Riyadh's relationship with
the non- OPEC producers: Mexico, Norway, and now Russia. Finally, there is Saudi Arabia's link to the major oil-importing regions -- most importantly North America, but also Europe and
Asia.

Given the size of the Saudi oil sector, the kingdom has a unique and critical role in setting world oil prices. Since its overriding objectives are maximizing revenues generated from oil
exports and extending the life of its petroleum reserves, Riyadh aims to keep prices high as long as possible. But the price cannot be so high that it stifles demand or encourages other
competitive sources of supply. Nor can it be so low that the kingdom cannot achieve minimum revenue targets. The critical balancing act of Saudi foreign policy, therefore, is to maintain oil
prices within a reasonable price band. Stopping oil prices from falling below the minimum level requires cooperation from other OPEC countries and occasionally from non-OPEC
producers. Preventing oil prices from rising too high requires keeping enough spare production capacity to use in an emergency.

This latter feature is the signal characteristic of Saudi policy. The kingdom can afford to maintain this spare capacity because of the abundance of its oil reserves and the comparatively low
cost of developing and producing its reserve base. In today's soft market, in which Saudi Arabia produces around 7.4 mbd, the kingdom has close to 3 mbd of spare capacity. Its spare
capacity is usually ample enough to entirely displace the production of another large oil-exporting country if supply is disrupted or a producer tries to reduce output to increase prices. Not
only does this spare capacity help the kingdom keep prices in check, but it also serves to link Riyadh with the United States and other key oil-importing countries. It is a blunt instrument that
makes policymakers elsewhere beholden to Riyadh for energy security. This spare capacity is greater than the total exports of all other oil-exporting countries -- except Russia.

Saudi spare capacity is the energy equivalent of nuclear weapons, a powerful deterrent against those who try to challenge Saudi leadership and Saudi goals. It is also the centerpiece of the
U.S.- Saudi relationship. The United States relies on that capacity as the cornerstone of its oil policy. That arrangement was fine as long as U.S. protection meant Riyadh would not
"blackmail" Washington -- an assumption that is more difficult to accept after September 11. Saudi Arabia's OPEC partners must also cooperate with the kingdom in part to prevent Riyadh
from producing a glut and having prices collapse; spare capacity also serves to pressure key non-OPEC producers to cooperate with Saudi Arabia when necessary. But unlike the nuclear
deterrent, the Saudi weapon is actively used when required. The kingdom has periodically (and brutally) demonstrated that it can use its spare capacity to destroy exports from countries
challenging its market share. This tactic is the weapon that Saudi Arabia could use if Moscow ignores Riyadh's requests for cooperation.

Saudi Arabia has triggered its spare capacity twice in recent history, once when prices were especially low. Both cases demonstrated that the kingdom will accept those low prices so long
as it suffers less than its targets do. In 1985, Saudi Arabia successfully waged a price war designed to force other oil producers to stop "free riding" on Saudi oil policy. That policy meant
that those states had to cooperate with the kingdom by reining in production enough to allow Saudi Arabia to produce the minimum level that it targeted. Oil prices fell by more than half
within a few months, and Saudi Arabia immediately regained the market share it had lost in the preceding four years, mainly to non-OPEC countries.

Then, in the 1990s, OPEC member Venezuela challenged Saudi Arabia by deciding to maximize its production. Although Venezuela had an OPEC quota of 2.3 mbd, Caracas embarked on
an ambitious policy designed to eventually triple its production capacity. Caracas knew it could not do this on its own, so it reopened its nationalized resource sector to foreign investment.
By the winter of 1996-97, Caracas was producing 3 mbd, knocking Saudi Arabia from its position as number one supplier to the United States. In response, Riyadh first tried reasoning with
Caracas. When diplomacy failed, Saudi Arabia raised its production by close to 1 mbd and induced the oil price collapse of 1998. Riyadh's actions were tough but effective. By engineering
a price drop, it had to withstand a painful drop in income -- but it achieved its main goals. Saudi Arabia reasserted its OPEC leadership, reestablished itself as the prime supplier of oil to the
United States, and induced non-OPEC producers Mexico and Norway to support OPEC's revenue-maximizing goals.

uncle sam needs them

Riyadh's relations with Washington are much more complex than they appear on the surface, because they involve unspoken understandings and a number of useful fictions. September 11
has complicated these understandings, because the publics in both countries are suspicious of the cooperation between the two governments. Washington recognizes Saudi Arabia's
critical role in the global oil sector, especially Riyadh's price moderation. Saudi Arabia, in turn, plays its Washington cards diligently. The kingdom has protected its position as the top U.S.
supplier. Today, Saudi Arabia supplies around 1.7 mbd of the roughly 10 mbd imported into the United States -- a market share higher than that of any competitor. The kingdom maintains
this share to show how important Saudi supplies are to the United States. The Saudi leadership can thus ensure that Washington will help defend Saudi Arabia, which means not only the
defense of the kingdom's oil fields and territorial integrity but the defense of the House of Saud.

This role does not stem directly from Saudi Arabia's position as the world's largest supplier. Indeed, if oil trading were left to market forces, the kingdom's oil exports to the United States

http://proquest.umi.com/pqdweb?index=11&did=000000107399221&S...PROD&VType=PQD&RQT=309&VName=PQD&TS=1090836004&clientId=28949 (3 of 8) [7/26/2004 3:31:09 PM]

Article View
would fall by half. Instead, Saudi Arabia pays a price for its market share, a price that fluctuates each month as market forces change. Saudi Aramco, the state oil company, earns about $1
a barrel less on sales to the United States than on sales to the countries of Europe and East Asia. That discount translates into a subsidy to U.S. consumers of $620 billion per year. In
return, the United States deploys military forces in the Persian Gulf, which is of course also expensive. And given U.S. sensitivity to Riyadh's policy concerns on an array of issues, from the
Arab-Israeli peace process to Kosovo to Central Asia, Washington pays the additional price of being constrained in its own foreign policymaking.

One of the hidden aspects of the relationship is the Saudi dependence on the United States for providing an expanding market. Although Asian demand for oil is expected to grow
dramatically in coming decades, no other economy rivals that of the United States for the growth of its oil imports. Over the past decade, the increase in the U.S. share of the oil market, in
terms of trade, was higher than the total oil consumption in any other country, save Japan and China. The U.S. increase in imports accounts for more than a third of the total increase in oil
trade and more than half of the total increase in OPEC's production during the 1990s. This fact, together with the fall in U.S. oil production, means that the United States will remain the
single most important force in the oil market. The hope of Saudi Arabia and OPEC for an increased market and for greater market share is uniquely dependent on growth in U.S. demand.
Hence it is not for security alone that Riyadh depends on the United States but for the very economic basis of the Saudi regime, which relies almost entirely on oil for revenue.

Although the U.S.-Saudi axis is often neglected, it can be blown out of proportion. When the ties between the two countries appeared to fray after September 11, some press reports
asserted that this separation of interests was unprecedented. It is true that Riyadh had expressed considerable displeasure with the Bush administration over the U.S. abstention from its
former active role in the Arab-Israeli peace process. But even before then, Washington and Riyadh clashed over oil prices; the Clinton administration even pressured other key OPEC
countries into increasing oil production.

It would be more accurate, in sum, to see the common interests of Washington and Riyadh as the intersection of two large and unwieldy sets of goals. In both countries, the size and value
of that connection have been undergoing serious review since September 11. To the degree that Washington decides to take action to reduce the U.S. economy's dependence on oil, it can
greatly affect the scale of increased oil production over the next few decades. It is because of that opportunity that the Russian challenge to Saudi Arabia has become tremendously
important.

bust and boom

It did not take long after the Soviet collapse for Western oil firms, investment banks, and policymakers to begin eyeing the oil reserves of Russia and Central Asia as a competitive
alternative to Middle Eastern crude oil. But the region's promise quickly evaporated as investors became bogged down in a swamp of corruption and the difficulties of doing business in
rapidly changing economies.

By the early 1990s, as oil exports from the former Soviet states plummeted, Middle Eastern producers started promoting their own energy resources as a cheaper alternative to
redeveloping the oil infrastructure of the former Soviet Union. Saudi Arabia and Kuwait even spoke of opening their oil and gas sectors to foreign investment as a way to attract investors
who might otherwise look to the post- Soviet Commonwealth of Independent States (cis). Assisting OPEC's efforts were high-profile scandals in Russia and Central Asia and the lack of
protection of minority shareholder rights in the Russian oil sector. A wary Western media even questioned the initial estimates of Russian and Caspian oil reserves.

But today, two advantages for the cis are clear. First, its reserves are much larger than previously assumed. Second, oil production capacity in the Middle East has stagnated for 20 years.
Indeed, overall OPEC production capacity is actually lower today than in 1980. The Middle East producers have no proven ability to exploit their resources beyond the levels that
international companies achieved before they were nationalized in the 1970s. Meanwhile, as exploration and production advance in such places as Kazakhstan, the reserve potential of the
cis will enlarge substantially. Eni, ExxonMobil, and others are developing what may be a giant field at Kashagan, estimated to contain 50 billion barrels. Lukoil, Russia's largest oil producer,
recently discovered a field of 5 billion barrels of proven reserves in the Russian part of the Caspian shelf; seismic data suggests that the field's vast size could triple the initial estimates
inside the license area alone. The discovery rate in Azerbaijan has been, in any case, disappointing, but conservative forecasts show that the Caspian shelf holds 75 billion barrels of oil --
115 percent of what bp Amoco credited to the entire cis in 2000.

Meanwhile, the Russian oil industry accelerated its consolidation after the 1998 financial crisis ended in a devalued ruble, which in turn enabled Russia to rapidly increase exports. As a
result, the industry could focus on developing its known core assets and exploring new assets more efficiently. Russian oil exports began to rise in 2000 for the first time since the Soviet
era. By the time Vladimir Putin was elected president in March 2000, Russian firms were ready to capitalize on the internal reforms that they had begun years earlier. Russia's producers
also benefited from long-term relationships they had developed with foreign firms, including Conoco, bp Amoco, ExxonMobil, Royal Dutch Shell, Halliburton, and Schlumberger.

Thanks to this process, the cis oil sector is now expected to increase exports by at least 2 mbd between 2002 and 2006. The Baltic Sea's export capacity could grow by as much as 0.4
mbd by 2004, mostly from Russia's four biggest producers through the Baltic Pipeline System. The Caspian Pipeline Consortium, which links Kazakhstan's oil fields to the Russian ports on
the Black Sea, will likely add 1.5 mbd by 2006-8. Exports from ExxonMobil and Shell projects in Sakhalin, in Russia's Far East, should add another 0.2 mbd by then as well. Indeed, the
resources along Russia's Asian frontier might be as vast as those in Central Asia. And Yukos, Russia's second-largest producer, is preparing to export to China about 0.5 mbd from its fields

http://proquest.umi.com/pqdweb?index=11&did=000000107399221&S...PROD&VType=PQD&RQT=309&VName=PQD&TS=1090836004&clientId=28949 (4 of 8) [7/26/2004 3:31:09 PM]

Article View
in eastern Siberia.

To compete with international oil firms and meet the demands of minority shareholders (including foreign investment funds), Russian producers have begun to improve their often awful
corporate governance records. The migration toward internationally accepted financial reporting standards has forced them to adopt better managerial and production practices. Efficiency
tools such as better software now enable many Russian managers to rationalize production, thereby increasing profitability and the effectiveness of long-term corporate investment.
Recently implemented judicial reforms and tax harmonization should translate into a better business environment for all Russian firms.

roll out the barrel

If the concrete plans of Russian and Central Asian oil companies and their international partners come to fruition, total cis exports from the former Soviet Union could equal Saudi exports
within four years. The threat of a "northern" oil boom that Middle East producers first feared in the early 1990s is now real.

The one factor that constricts the ability of Russia and Kazakhstan to increase exports more than production capacity is infrastructure -- namely, inadequate pipelines and port facilities. But
since September 11, export infrastructure has been enlarging and will accelerate. Most of the increased exports of the past two years have come from increased loading capacity on the
Black Sea and in various terminals in the three Baltic states, but this imbalance, too, is changing. In 2001, oil began flowing from the 1,000-mile Caspian pipeline, which provides a direct
route for Kazakh crude oil exports to world markets via the Black Sea. Controlled by Lukoil, Chevron, Shell, and ExxonMobil, the pipeline is expected to handle 1.5 mbd for export by 2012.
And in the Baltic, Moscow is pursuing extensive plans for shipping out more oil. The new Baltic pipeline will deliver oil from Russia's far north and western Siberia, much of which is intended
for Western markets, including the United States.

All of Russia's major oil firms are competing for European and U.S. market share, but it is Lukoil that is furthest along. The company has a long-term plan to become an international
contender and sees itself as the legitimate "fourth sister" of industry leaders ExxonMobil, Shell, and bp Amoco. Lukoil expanded operations to southern Europe a few years ago by
purchasing refining assets, pipelines, and ports in Bulgaria and Romania; it recently started to negotiate purchase of a refinery from Hellenic Petroleum in Greece. In 2000, it bought Getty's
1,300 gas stations in the United States. Although the stations are already partially supplied from Lukoil's refinery in Bulgaria, the company intends to acquire a large refinery in the United
States to increase Russian deliveries to Getty's pumps.

But Russia's international acquisitions have not always gone smoothly. In 1997, three Russian companies, led by Lukoil, signed a $3.5 billion agreement with Iraq to develop the West
Qurna field, which has an estimated 7.8 billion barrels of reserves. By 1999, the consortium was lobbying the Russian government to end U.N. sanctions on Iraq, which were hindering
development. Several other Russian producers also have contracts with Iraq that cannot be implemented until the U.N. sanctions regime is over. Iraq has threatened to cancel all these
concessions unless Russia starts developing. Complications have also arisen in Europe. In December 2001, Yukos failed to reach an agreement to purchase a stake in a refinery and
offshore terminal on Lithuania's Baltic coast. The terminal would enable Russian producers to ship high-quality, low-cost refined oil products in large tankers to New York from Lithuania, a
possible future NATO member. Whether or not the obstacles in Lithuania and Iraq can be cleared, however, Russian producers will continue to expand their influence into historical markets
and beyond. In the coming months, several Russian firms will compete in privatization tenders for downstream oil assets in Poland, Latvia, the Czech Republic, Slovakia, and Croatia.

a new strategy

Until September 11, the United States pursued two often conflicting goals: encouraging Russia to better protect U.S. corporate investments in the Russian energy sector, and assisting the
Caspian countries in developing and exporting their own hydrocarbons, thereby avoiding pipeline routes through Russia.

Events are now squaring the circle. Russian companies and the Russian government are moving rapidly on improving the rule of law, but they are not providing significant advantages to
U.S. and other foreign direct investors in the oil sector; Russian firms want to keep the "crown jewels" to themselves. Yet these same firms, intent on expanding abroad, are becoming more
open to joint ventures with international firms when they require Western technology, particularly in the offshore areas of the Arctic Ocean. Meanwhile, the new environment of cooperation
and Russian corporate interests in the Caspian countries have moved Moscow to support the independent export pipelines that expedite development schemes in Azerbaijan and
Kazakhstan.

Even so, significant room remains for U.S. influence, whether good or bad. If it takes the wrong track, the U.S. government could prevent Russian industry from becoming more transparent.
Unilateral economic favors dispensed by Washington, for example, could bankroll Russia's major oil firms with undeserved credit as a way to lessen OPEC's influence in the oil market.
Such a politically motivated move would institutionalize the status quo by sheltering Russian companies from the demands of the marketplace. Ill-conceived investments enable corrupt
managers to continue their mistreatment of shareholders and mismanagement of assets without sanction.

http://proquest.umi.com/pqdweb?index=11&did=000000107399221&S...PROD&VType=PQD&RQT=309&VName=PQD&TS=1090836004&clientId=28949 (5 of 8) [7/26/2004 3:31:09 PM]

Article View
If the U.S. government desires to get more involved in supporting Russian oil exports, it must move beyond the knee-jerk reaction of siding with American firms in their disputes with their
Russian counterparts, as was often the case before September 11. Equally important, U.S. overseas trade and development agencies as well as international financial institutions should
ensure that the rule of law, including minority shareholder rights, has been honored before promoting credit lines to Russian producers.

The United States can also support legislation that further promotes property rights in the region. Transfer-pricing legislation, already implemented in Kazakhstan and under consideration in
Bulgaria, can help stop domestic and foreign strategic investors from moving profits out of publicly traded subsidiaries. Such atrocious (and all too common) corporate behavior not only
destroys minority shareholder value at the subsidiary level; it can also devastate burgeoning tax bases in emerging economies. In addition, Washington can aid the effort to stop such
practices by improving the educational and training programs for tax officials and the legal systems that are required to implement such legislation.

In the oil and gas sector, Americans must help the Russians and the Kazakhs determine the most efficient export routes for Russian and Caspian oil and arrange financing for these capital-
intensive projects. This move would be radically different from the policy pursued in the 1990s, when the United States pushed export routes that tried to free the Central Asian states from
Russian and Iranian control rather than pursuing the most economically viable options. Moreover, Lukoil recently stated it would even consider participating in the U.S.-backed Baku-
Ceyhan pipeline, which will bring oil from the Caspian to Turkey's Mediterranean coast. As elsewhere, global investors should be free to pick winners and demand corporate reform and
increased production when economically justified. Investors remain the best positioned to make demands on those managers who still do not understand that the company's interests are
aligned with the interests of its shareholders.

how low can you go?

The emerging battle for market dominance between Russia and Saudi Arabia is a clash between two extremely different cultures and involves radically different agents. True, both the
Russian and the Saudi governments are unusually dependent on the revenues generated by oil or gas exports. But this dependence aside, the Russian oil sector is a lot more like the
United Kingdom's than it is like Mexico's or Norway's -- let alone that of the former Soviet Union. The Russian government has extremely limited powers over how Russian firms allocate
their sales or investments. Moscow can encourage or limit access to pipelines under government control, but it cannot control what companies do.

In contrast, Saudi Arabia is governed by a royal family that sees its interests as part and parcel of the state it rules. The national oil company, Saudi Aramco, is the state's sole instrument
for pursuing its aims. Saudi Aramco's commercial interests are those of its shareholder -- the state -- and the society over which its shareholder governs. On the Russian side, however, the
state has become increasingly a representative institution that provides for the public good through taxes. Yet it owns a rapidly decreasing amount of the country's energy resources and
enjoys no monopoly over the Russian oil industry. The state has ceded this terrain to a group of publicly traded companies eager to expand rapidly in a competitive international
environment.

When Saudi Arabia and other OPEC members sought Russian cooperation last fall in managing the international oil market, they had a simplistic and wrong-headed view of Moscow's
position. Encouraged after gaining the cooperation of Mexico, Norway, and Oman in a previously oversupplied market in 1998, the Saudis did not understand the new Russia. It was
becoming better off financially, but its government remained too weak to actively limit the country's oil exports. Nor was Moscow so dependent on oil revenue that it had to cooperate with
the Saudis. Thus Riyadh made a tactical error: it tried to blackmail Moscow by threatening a price war.

Russia did not take kindly to the threat. First, its biggest companies, which had worked so hard in raising oil production over the past two years, especially Yukos and Surgutneftegas,
resented any attempts to limit their exports as unwarranted state intervention into corporate plans. They also saw the move as a violation of an explicit agreement between the government
and the private sector, in which companies would become more transparent and pay taxes but remain free to grow with less government interference. Second, there was widespread
Russian anger at the blunt OPEC effort to blackmail Moscow. Riyadh's oil policy was seen as an extension of Saudi support for Afghanistan's anti-Russian rebels in the 1980s, the
independence movement in Central Asia in the late 1980s and early 1990s, the Chechnya conflict, and Islamic educational institutions in Russia -- all considered threatening to Russian
interests. But Moscow's reaction was also calculating. Both Moscow and the Russian companies knew that Russia depended far less on the international price of oil than did Saudi Arabia.
Some Moscow officials therefore welcomed a price war, which they saw Russia as outlasting. (The income and capital expenditures of Russian firms are ruble-based, so these companies
benefit from a ruble depreciation against the dollar.)

Like Saudi Arabia, OPEC was also miffed. Russia's initial rebuff of the approaches of OPEC's leaders, when they sought Russia's cooperation in reducing output, angered virtually all its
members. The OPEC countries were annoyed that Russia was increasing its output so aggressively at a time when OPEC countries were restraining themselves. And just as the Russians
equated Riyadh's position on oil with Riyadh's support for anti-Russian institutions, the OPEC world saw a direct attack on its own values. From OPEC's perspective, Russia was stealing
market share that rightfully belonged to countries with far deeper oil reserves.

From Moscow's perspective, however, Russia was reclaiming lost market share. Indeed, Moscow sees the history of oil in the 1980s as one of a price war declared by Saudi Arabia on all
other oil- producing countries. The aforementioned Saudi-engineered price collapse of 1985-86 led to the implosion of the Soviet oil industry - - which, in turn, hastened the Soviet Union's

http://proquest.umi.com/pqdweb?index=11&did=000000107399221&S...PROD&VType=PQD&RQT=309&VName=PQD&TS=1090836004&clientId=28949 (6 of 8) [7/26/2004 3:31:09 PM]

Article View
demise. From this perspective, Moscow's companies were simply reclaiming the international market share that had been stolen by Riyadh 15 years earlier.

In any event, both sides decided to declare a truce by the end of 2001. Russia concluded that cooperating with OPEC and other independent oil producers was in its best interest -- for now.
In the end, Moscow felt that a price collapse would be bad for the world economy and the stability of oil exports.

Despite the truce, however, the battle is not over. When it comes to compliance in preventing overproduction, Moscow and Riyadh remain suspicious of each other. Russia is increasingly
convinced that it could withstand a price collapse better than any of the OPEC countries. Moscow has made no excuse for its inability to fully enforce compliance, but it knows that nature is
on its side; tanker loading at the Black Sea and Baltic terminals is always reduced during the harsh winter months. Moscow also believes (rightfully) that its exports are far more transparent
than those of OPEC members, whose exports are measured by journalists rather than by government customs data. And Moscow knows that Saudi Arabia has been exceeding its export
quotas over the past year far more egregiously than anyone else has. Recriminations will fly from both sides in the months ahead.

In the long term, Moscow may have far more going for it than Riyadh. Yukos, Lukoil, and other companies are dynamic and growing, and they are now poised to recapture and expand on
the production base of the former Soviet Union. Furthermore, they are highly integrated and are forming alliances with international companies, and so they can sell their growing output to
enlarging networks in Europe, Asia, and the Americas. Through their joint ventures, they can tap the technology and capital of Western firms in developing new resources, especially in the
Far East and the Arctic Ocean.

Riyadh, on the other hand, might have vast known reserves, but it also has a closed state monopoly. Most alarming, Saudi Arabia has been unable for 20 years to increase its production
capacity. Nor is its position unique: few OPEC countries in 2002 have more production capacity than they did in 1990 or 1980. The exceptions are countries such as Algeria and Nigeria,
whose governments have encouraged foreign investment in the petroleum sector. History does not look kindly on monopoly-company countries. Riyadh has only one clear weapon left: the
spare capacity that can be unleashed whenever it chooses to punish those who would challenge its oil supremacy.

winners and losers

Thanks to the potential growth of Asian and U.S. demand, there could be room in the future for both Saudi and Russian producers to gain market share if they cooperate. But it is more
likely that the policies pursued by Moscow and by Washington will restructure the battlefield.

Although Russian oil is not nearly as large in its reserve base or as cheap to produce as Saudi crude, it remains vast and far greater than is generally recognized. Market forces have
unleashed a dynamic transition in its oil sector that will allow Russia to challenge OPEC and Saudi Arabia. In an economy governed by market forces, Russian companies are poised to
capture the lion's share of growth in demand in China, India, and even the United States, through joint ventures.

The cost structure of the Russian energy industry is a significant factor in the equation. As long as costs are largely ruble- denominated and the ruble is stable, Russian industry is protected
from low oil prices, while capital investment flows are sheltered from price volatility. For the Russian government, the situation is more complex, but Russia is also more sheltered from low
oil prices than are other exporting countries. Like OPEC exporters, it depends on revenues from export taxes. But unlike OPEC countries, it also takes in significant revenue from domestic
sales and from taxes on huge natural gas exports to Europe. Thus the major question is whether Saudi Arabia can afford a sustained price war to block Russian and cis oil development.
That feat might require oil at $10 a barrel for two years or more -- a situation as frightening for Riyadh as it is for other OPEC countries.

The critical element that Washington can add is a policy mix that would arrest the growth of U.S. oil demand by adopting a transportation policy that forces greater efficiency. This effort
would take the post-September 11 world seriously. If both Washington and Moscow encouraged what their companies and publics already do -- increasing production in both countries
while restraining demand in the United States -- the stage could be set for a very new petroleum world. The time has come to recognize that September 11 has opened new vistas for
Russia, the United States, and OPEC.

Edward L. Morse is Executive Adviser at Hess Energy Trading Company and was Deputy Assistant Secretary of State for International Energy Policy in 1979-81. James Richard is a
portfolio manager at Firebird Management, an investment fund active in eastern Europe, Russia, and Central Asia.

^ Back to Top « Back to Results Article 1 Publisher Information

Mark Article Abstract , Full Text

Copyright © 2004 ProQuest Information and Learning Company. All rights reserved. Terms and Conditions

http://proquest.umi.com/pqdweb?index=11&did=000000107399221&S...PROD&VType=PQD&RQT=309&VName=PQD&TS=1090836004&clientId=28949 (7 of 8) [7/26/2004 3:31:09 PM]

Article View
Text-only interface

http://proquest.umi.com/pqdweb?index=11&did=000000107399221&S...PROD&VType=PQD&RQT=309&VName=PQD&TS=1090836004&clientId=28949 (8 of 8) [7/26/2004 3:31:09 PM]