Kremlin Stifles Pipeline Capacity

By Gustavo Coronel l July 30, 2010

Vladimir Putin       Igor Sechin        Khodorkovsky

Oil is produced but it must be refined, transported and exported to become profitable. Ideally, this sequence should be guaranteed before the first stage of production begins. This guarantee is usually possible in most producing and exporting countries but not in Russia, where transport of the oil is a jealously guarded state monopoly.

The company Transneft builds and manages all Russian pipelines. Any private attempt at breaking into this sector of the industry has been firmly repressed. In the early 2000’s Mikhail Khodorkovsky, the owner of YUKOS, attempted just such an action and this contributed significantly to his fall and imprisonment.

In 2002 his company had been increasing oil production and was refining some 120,000 barrels per day in Angarsk, in the region of Tomsk. He envisaged that the refinery could be made to triple its capacity, up to some 340,000 barrels per day, and that the new products could find a ready market in booming China. The problem was that there was no manner of transporting the products. Pipelines were saturated and instead of building more pipeline capacity the Russian government had instituted an unsatisfactory quota allocation that did not allow expansion of production. The quota system became, instead, a source of corruption.

Although he tried to interest Transneft in the project Khodorkovsky found no positive reaction. He even offered to build the pipeline and give it over to Transneft, but still did not receive a positive response. In retrospect it seems clear that the Kremlin simply did not want to give YUKOS a guaranteed access to the pipeline.

Khodorkovsky insisted, criticizing the government plan to build an alternate pipeline, correctly claiming it “would be more costly.” He went as far as saying that “this is a business matter…the government should not get involved… in this case a purely political decision should not be made.” This insistence angered the Kremlin, especially Russian Prime Minister Vladimir Putin’s close collaborator, Igor Sechin, now the deputy prime minister, chairman of Rosneft and the Kremlin’s undisputed gray eminence. When Khodorkovsky also tried to sell a portion of his company abroad he was seen as having gone too far. This along with the expectation of a challenge to Putin’s electoral power sealed his doom. He was arrested in 2003 and ultimately convicted on fraud and tax evasion charges, following the freezing of YUKOS assets by the Russian government, whereupon the company was declared bankrupt.

Another example of the government’s fierce control over the pipelines is the case of the Tengiz oilfield, located in western Kazakhstan, near the Caspian Sea. Thirty years after being found this field is “running at about half speed.” The reason is similar to the YUKOS case described above: there is no pipeline capacity to move the oil that could be produced. The existing 935-mile pipeline to the Black Sea, CPC, can only carry about half of what the oilfield could produce, imposing a severe limitation on the owners of the field, Chevron, Exxon Mobil and Russian company Lukoil.

All attempts by the oilfield owners to convince the Russian government to expand the capacity of the pipeline have failed, forcing them to transport part of their current production by railroad. Again, the reason is one of control. The Russian government prefers to try to build a new pipeline that they can control completely, since Chevron owns half of the shares of the existing one. Meanwhile any expansion of the existing pipeline is suspended and the oilfield owners are losing significant amounts of money, since they already have a production capacity that sits partially idle. Vladimir Putin himself seems to call the shots regarding Russian oil pipeline strategy.

Economics are currently influencing this strategy, as Russia is facing severe fiscal deficits that might extend into the next years. The government is being pressured into selling minority stakes in some of their companies. Finance Minister Alexei Kudrin said July 27, 2010 in Moscow: “We will sell significant stakes in state companies on the market. We plan to keep controlling stakes.”

If this plan goes through, Russia would be conducting a second big wave of privatizations, the first one taking place during the 1990’s. That first privatization wave was very controversial, as many state companies ended up in the hands of government friends at bargain prices. This time around the government has promised to conduct a very transparent process, market prices prevailing. Although the list of companies to be partially privatized is not yet officially known some candidates include Rosneft, the oil company and, surprisingly, the pipeline monopoly Transneft.

Giving up partial control of the oil pipeline monopoly could signal a major shift in the Russian energy strategy and one that could herald the opening up of the sector to private international investment and to a weaker Russian grip on the movement of oil and gas across the region and into foreign markets.

However, at the end of the day, Russia retains controlling shares in these energy companies. Foreign investors would enter into highly risky ventures and may eventually face a couple of likely scenarios: 1) state expropriation of private assets – the YUKOS model; and/or, 2) virtual state expropriations of private oil interests – the Chevron-Exxon Mobil model.

Gustavo Coronel, who served on the board of directors of Petróleos de Venezuela (PdVSA), has had a long and distinguished career in the international petroleum industry, including in the USA, Europe, Venezuela and Indonesia. He is an author, public policy expert and contributor to

SFPPR News & Analysis.