Today’s Analysis: Peak Oil: Russian Style


The concept of peak oil is gathering strength. And evidence from Russia suggests that one way or another, the world's number two oil producer is trying to provide substantive proof that the days of rising production are a thing of the past.

Russia's recent political shifts have had a major effect on the country's oil industry. According to the Wall Street Journal "Russian oil production could stagnate for years, industry officials are warning, a shift that could help keep world prices for fossil fuels high."

Russian oil production has kept world oil prices from climbing higher. Indeed, "A 50% jump in Russian output since 1999 has been the largest single source of new oil for the world market, helping to slake surging demand from China and keeping prices from jumping even higher. But Russian output has fallen slightly since last fall as the Kremlin's crackdown on OAO Yukos and other moves to increase state control of the sector have caused a sharp decline of investment in the sector."

As the Journal reports: "Since 2000, the remarkable rise of about 2.7 million barrels a day in Russian oil production has met close to half the increase in global demand of 5.88 million barrels a day, according to data compiled by the International Energy Agency. But Russian output peaked in September at about 9.4 million barrels a day and has been in the doldrums since. Russia produced an average 9.3 million barrels a day in the first four months of this year, according to official data."

The current situation has very little slack. "Global supply is tight this year even with producers pumping flat out to meet strong demand, which is forecast by the IEA to grow by 1.8 million barrels a day to 84.3 million barrels a day. Russia isn't expected to meet much, if any, of this growth."

To be sure there are multiple reasons for the situation, and politics is at the top of the list. According to the Journal "Most of the production drop has occurred at cash-starved Yukos, whose accounts are frozen due to $28 billion of back-tax claims." Still, the damage can still be seen throughout the entire sector, as "industry officials say the chilling effect of authorities' destruction of the company -- once one of Russia's fastest-growing -- has hurt confidence across the industry just as Russian oil fields need billions of dollars in new investment."

There is no sign of a major acute falling off in production. And there is no palpable sign of a reserve problem, at least not yet. The Wall Street Journal reported: "In a recent interview, Vagit Alekperov, president of No. 1 Russian producer OAO Lukoil, said he expects industry production to stabilize between 9.2 million and 9.4 million barrels a day over the next several years after ["slight growth"] this year. Rising domestic demand is likely to leave less crude for export, he said. Government forecasts also see production stagnating through at least 2008, after rising 9% or more annually in recent years."

The U.S. view, influenced by frustration over Russia's inability to deliver on the potential for a greater partnership with U.S. oil companies is that production should be a lot better: ["It should be 10 times that or more, given the reserves that are here," Energy Secretary Sam Bodman said during a visit to Moscow last week.]

And of course, there are always the games of politics, money, and power to be dealt with. The Wall Street Journal suggested that sa part of the problem may be jus that: "Some of the Russian executives' pessimism could be a calculated effort to push for tax relief and other government help. Surgut, for example, expects annual growth rates of 5% or better over the next several years for its production. Lukoil expects its oil output to rise annually between 3.5% and 4% until 2011."

The conclusion is that the huge production jump of recent years, came from an improvement in technology, which is not likely to be repeated. "Mr. Alekperov suggested the big production gains of recent years couldn't be easily repeated because a massive application of new technologies to update west Siberian fields, which has yielded bigger flows, had largely run its course. To boost production further would require much more investment and new fields. Even if begun now, new projects would take years to complete."

Russian experts are looking at the situation over the intermediate term, not as an immediate problem. ["If we don't work for the future now, the country could see a decline in output in five to 10 years," Vladimir Bogdanov, chief executive of No. 4 producer OAO Surgutneftegaz, said in an April interview with a Russian news agency.]

As usual, the Kremlin is good about talking, and has difficulty, on a good day, at delivering. "Indeed, President Vladimir Putin has repeatedly promised that Russian output will continue to grow. His government is working on a program aimed at stimulating output, though it is still months away from approval, officials say. The plan calls for steps to encourage exploration to replace existing fields as they run down -- for several years, Russia has been producing more oil each year than its companies have discovered -- as well as tax changes. Current rules mean the state takes about 90% of the revenue when world prices rise beyond $25 a barrel. Companies complain that doesn't leave enough for investment."

But, as usual, there is no relief in the short term, especially when it comes to Russia's pipeline bottleneck. "The Kremlin also is promising to spend billions over the next several years to expand export pipelines. Government officials said as much as three million barrels a day of additional export capacity could be in place by early in the next decade. Analysts at Wood Mackenzie Ltd. in Edinburgh, Scotland, estimate Russian fields are declining at rates of between 5% and 10% annually. Yet Ian Woollen, senior Russian analyst at Wood Mackenzie, is bullish about the medium-term prospects for Russian output, forecasting an output peak of more than 11 million barrels a day in 2010."


The declining state of the Russian oil industry is not new. We've covered it here before. There is now a rising consensus, that the concept of Peak Oil, put forth in "Hubbert's Peak," by Kenneth S. Deffeyes, is actually here. That means that major decision makers, although far from acknowledging it publicly, are thinking about it, and are perhaps acting as if indeed it is truly here.

The markets are surely factoring in the possibility. If that weren't true, then why would oil prices be climbing in the face of rising oil supplies reported in the U.S. for the last three months.

If the energy industry wasn't considering peak oil as a possibility, then why are the weekly rig counts continuing to hold near peak levels. And why are natural gas rigs pumping at full capacity even though supplies are ample.

It's hard to believe. But, it would seem that the quiet consensus is that we may have finally hit that inflection point where global energy resources are no longer a precious resource, but a diminishing one. The only question is whether this is a true geological phenomenon or one that is being manufactured by oil producers to keep prices artificially high.

Oil Market Summary And Outlook: Distillate Still Causing Supply Concerns

Crude supplies are above average. But traders are concerned about diesel, jet fuel, and heating oil, now. The upshot is that prices remained above $50 for crude. Natural gas stocks are starting to move higher.

Marketwatch reported: "The Energy Department said crude supplies rose 1.4 million barrels in the week ending May 27. Gasoline supplies rose 1.3 million barrels, while distillate supplies rose 700,000 barrels. Separate data from the API showed crude supplies up 1.3 million barrels, distillates up 783,000 barrels and gasoline down 1.4 million barrels. The Energy Department said that over the past four weeks, gasoline demand has averaged more than 9.3 million barrels a day, or 1.8% more than in the same period a year ago. Distillate fuel demand of almost 4.1 million barrels over the past month is 5.2% greater than the year-ago period. Demand for kerosene-type jet fuel has grown 5.5% compared with the year-ago, four-week period."

So as usual, it's more about supply than demand. And the persistent variable seems to be refining capacity. U.S. refineries switched over to gasoline a few weeks ago and now distillate supplies are starting to fall. But, the economy is strong enough to keep demand for diesel up due to truck traffic, as well as increased SUV traffic.

What is likely is a continuation of the trading range in oil, as supply pressure for products continue to plague the system.

OPEC is still talking production up, and is vowing to deliver a cushion for the winter. So expect no changes in quotas in June.

Bottom line: the energy markets are once again attractive. In the Rigzone Store:

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