Peak Oil News: Russian output slumps as oil price hits a record

Wednesday, April 16, 2008

Russian output slumps as oil price hits a record


By Guy Chazan And Neil King Jr

Russian oil production has begun to stagnate and even slump, adding to market uncertainties that have helped push oil prices to record highs.

Russian oil production, for years a vital font of new crude for world energy markets, has begun to stagnate and even slump, adding to market uncertainties that have helped push oil prices to records even as the global economy founders.

Russian supply in the first three months of this year fell for the first time this decade, averaging 10 million barrels a day, a 1% drop from the year-earlier period, according to the International Energy Agency, the industrialized world's energy watchdog. That is dismal news for a country that saw double-digit-percentage output growth earlier this decade.

On Monday, U.S. benchmark crude rose $1.62, or 1.5%, on the New York Mercantile Exchange to settle at $111.76 -- an all-time high, even after adjusting prices during past booms for inflation.

The slowdown in Russia, the world's second-biggest oil exporter after Saudi Arabia, has intensified already widespread concerns about long-term oil supply amid diminishing output from once-huge fields like Alaska's Prudhoe Bay and Mexico's Cantarell field in the Gulf of Mexico. Fading optimism that strong Russian output this year would offset ebbing flows from once-reliable sources like the North Sea has increased jitters in an already tense oil market.

As prices have soared, Saudi Arabia and other members of the Organization of Petroleum Exporting Countries have argued that anticipated bursts in new supplies from non-OPEC countries mean the world hasn't needed additional barrels from OPEC. Even with an easing in oil-demand growth due to the U.S. economic downturn, many analysts still worry that a global supply pinch later this year could send prices still higher.

"There isn't a lot of supply coming on right now, so this [lack of non-OPEC growth] is framing the whole narrative of the market," said Roger Diwan, a financial energy adviser at PFC Energy in Washington.

Russia's production slump also highlights a troubling reality: Despite soaring oil prices in the past five years, crude output among non-OPEC countries has remained essentially flat since 2005, defying the normal link between high prices and increased production. The reasons for that plateau range from spiraling exploration costs to the increasingly remote climates where new oil pockets are being found.

Some senior officials in Russia, such as the country's natural-resources minister, Yuri Trutnev, are now predicting that the country's full-year production may be lower than last year's. Opinion, however, is split. Russia's energy ministry says it still expects a rise of 1.8%, while the Paris-based International Energy Agency is predicting 0.8% growth.

Still, it is clear that Russia's oil production has hit at least a temporary ceiling after years of strong growth.

Russian oil output collapsed after the breakup of the Soviet Union as the price of crude plummeted and investment dried up. But it began to recover in 1999 as newly minted private oil companies used Western techniques to rejuvenate mature fields. Russia became the world's biggest source of incremental new barrels of oil as output grew from six million barrels a day in 1996 to an average of 9.4 million barrels last year.

Saudi Arabia during the same period went from around 8.2 million barrels a day to 9.2 million barrels last year, according the U.S. Energy Information Administration.

Russia's challenge now is that its older Siberian fields, which accounted for much of the rebound, have reverted to their long-term downward trend. Russia will need to open up the remote, untapped expanses of East Siberia to ensure future growth. But so far, oil companies have been deterred by heavy taxes that provide little incentive to invest in so-called greenfield production.

Business sentiment has also suffered from growing state interference in the energy sector, typified by the nationalization of oil giant OAO Yukos and the travails of foreign investors like Royal Dutch Shell PLC, which was forced to sell half its stake in a big project off Russia's east coast to the state-run gas company. BP's Russian joint venture, TNK-BP, has also come under pressure: Last month, intelligence services arrested one of its employees on suspicion of industrial espionage.

In an interview, Leonid Fedun, vice president of OAO Lukoil, one of Russia's biggest oil companies, blamed the first-quarter slip in Russian production on an electricity-supply crunch in western Siberia and a mild winter. Higher temperatures mean Siberia's icy ground is less stable, making it harder to move drilling rigs between oil wells. "Instead of the six to seven months we normally have to work in, we had only 1½ months," said Mr. Fedun.

He acknowledged that the fall also reflects a longer-term trend -- the depletion of Siberia's older fields. "Western Siberia is repeating the fate of Prudhoe Bay, with a time lag of five to six years," he said. "When the well's productivity falls, you have to keep drilling more and more. You've seen it in Alaska and the Gulf of Mexico, and now you're seeing it in Siberia."

Oil companies are dealing with the depletion of reserves in western Siberia by diversifying. Lukoil, for example, is focusing on new provinces like the North Caspian Sea, and expanding abroad in places like Turkmenistan.

But even new developments are failing to offset the decline. Sakhalin 1, a huge project off Russia's east coast led by Exxon Mobil Corp., accounted for much of Russia's production growth in 2007. But output there will drop by more than 25% this year, according to OAO Rosneft, the state-run oil giant that is a partner in the project. In a statement, Exxon said it "has met and continues to meet or exceed the project production targets approved by the Russian authorities."

In a bid to kick-start investment, Russia's government recently unveiled a $4.2 billion tax cut for the sector. It was broadly welcomed in the industry. "It's a very important point that the Russian government has realized that with cost growth and inflation, there needs to be additional relief for companies to develop fields," said Bob Dudley, chief executive of TNK-BP.

But it may not be enough. Lukoil's Mr. Fedun says Russia's oil industry needs $1 trillion of investment during the next 20 years just to maintain production of 10 million barrels a day. Analysts worry the tax cut is inadequate to achieve that. "We still do not see it generating enough free cash flow to the support higher investment levels," Citigroup wrote in a recent report.

Citi says it still expects Russian oil volumes to increase by 1.5 million barrels per day between now and 2012, largely thanks to the ramp-up of new projects in eastern Siberia. But it cautioned: "Russian oil production growth is no longer to be taken for granted."

Fading Russian production would put an even greater weight on projects elsewhere in the world, despite troubling signs even in the oil-rich Middle East. Most forecasts predict that liquid fuel demand world-wide will hit 100 million barrels a day by 2015, up from around 86 million barrels a day now.

But to get there, producers will first have to keep abreast of steep declines in existing fields. That decline rate now subtracts an estimated 4.5 million barrels a day from annual output. Many big producers like Saudi Arabia, however, are now looking to preserve some fields for longer-term gain, instead of pumping to meet rising world demand. Saudi news reports quoted King Abdullah over the weekend saying that new oil finds in the kingdom should be left in the ground. "With grace from God, our children need it," he said.

Spiraling costs and a shortage of manpower and equipment has hampered production growth in OPEC and non-OPEC production. With much of the output growth in recent years coming from deep offshore drilling, oil companies have seen the cost of offshore rigs triple in the past five years. The most expensive drilling ships can now fetch more than $700,000 a day.

Former big producers like the U.K., Norway and Mexico are also fighting to squeeze oil from once mighty but now increasingly old and tired fields. In Canada, where output is increasing thanks to massive investments in Alberta's oil sands, production costs now top $65 a barrel, by some estimates.

There are bright spots on the production front that could ease tightness in global supplies starting later this year. Analysts point to big projects in the Caspian as well as deep-water projects off Australia, Brazil and in the Gulf of Mexico, including BP's long-delayed Thunderhorse platform. The U.S. also expects ethanol production to hit 550,000 barrels a day this summer, up from 418,000 barrels a day last year.


At 9:18 AM, April 17, 2008, Anonymous said...

"People in communities need to look at re-localisation, and not globalisation", you write in your article.
That is of course what we will be forced to do, like it or not, when our annual energy production has passed its peak and begins to decline.

Peak Humanity

At 9:07 AM, May 29, 2008, Anonymous patrick said...

i doubt that the gradual increase in demand throughout the world should be causing such sharp increase in price


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