Who owns it?

Tony Wood

  • Wheel of Fortune: The Battle for Oil and Power in Russia by Thane Gustafson
    Harvard, 662 pp, £20.95, November 2012, ISBN 978 0 674 06647 2

There is no shortage of turning points in Russia’s 20th-century history, from the October Revolution of 1917 to the German defeat at Stalingrad in February 1943, to the overnight disappearance of the Soviet Union at the end of 1991. But as well as these obviously pivotal moments, there are other, hidden hinges of the country’s fate. Geologists had long suspected that the ground deep beneath the swampy middle reaches of the Ob River might contain oil, and an initial expedition in 1959 found a petroleum reservoir near the village of Shaim. In early June 1960, Well R-6 was sunk; after 18 days of drilling to a depth of 1500 metres, it began to spew forth oil at a rate of 400-500 tons a day – the first industrial-scale find in Siberia. Success at Shaim set off a feverish burst of exploration, and more than two dozen fields were found in the area over the next four years. The biggest single discovery in the history of Russian oil was made in May 1965: the super-giant Samotlor field, at its peak in the 1980s the world’s second largest, and even now among the top half-dozen, producing more than 35 million tons of crude a year.

West Siberian oil quickly came to play a central role in the Soviet economy. There had been oil booms in Russia and the USSR before: Baku’s wells enabled the tsarist empire briefly to overtake the US as the world’s leading producer at the turn of the 20th century. After the Second World War the oil sector’s centre of gravity shifted to the fields along the Volga, but the Siberian discoveries were of a different order: their sheer scale meant that by 1975 the region accounted for almost a third of Soviet oil production; by 1980 more than half the USSR’s oil came from the Ob basin. The historical significance of these finds didn’t derive from their size alone: they turned the USSR into a major exporter just before global oil prices spiked with the crisis of 1973, giving the Soviet leadership vastly increased revenues. The flood of oil money arrived as the country’s massive industrial base had begun to stagnate, helping to compensate for – and mask – slowing productivity across the rest of the economy. Energy resources gradually came to predominate among Soviet exports, rising from 16 per cent in 1970 to 47 per cent in 1987. Ministers squeezed the oil industry for more crude to cover other shortages: one Russian oilman reported getting a phone call from the premier: ‘We’re short of bread,’ he said – ‘give us three million tons of oil above the plan.’

Oil exports were a bulwark of Brezhnevism, but they turned into the Soviet Union’s Achilles’ heel. In 1986, world oil prices dropped from close to $30 per barrel to less than $10, leading to serious problems for the Kremlin’s finances. Gorbachev’s government was forced to borrow heavily in order to import food, and industrial investment shrank , which further depressed output. This spiral of debt was an important factor in the escalating economic crisis of the USSR’s final years. It’s an interesting irony that the vagaries of a capitalist commodity market should have contributed to Communism’s ultimate downfall.

After the disintegration of the Soviet Union oil output slumped drastically from a peak of 570 million tons in 1987 to a low of 303 million in 1996 – a 47 per cent drop. Today Russia is an energy superpower again, second only to Saudi Arabia in levels of oil production: in 2011, it accounted for 13 per cent of world output, and 12 per cent of proven reserves outside the Middle East. What happened? Thane Gustafson’s Wheel of Fortune is the fullest account so far of Russian oil in the 1990s and 2000s. Gustafson, who is now based at Georgetown University, was for a time an analyst at the Rand Corporation and spent 15 years researching Russian oil at Cambridge Energy Associates. In 1989 he published Crisis amid Plenty, on Soviet energy policy under Brezhnev and Gorbachev; Wheel of Fortune is ‘in basic respects a sequel’ to that volume, built on an impressive grasp of the way the Russian oil industry works. But its arguments also have a wider relevance for understanding the country’s post-Soviet fortunes.

Gustafson’s main contention is that the events of the 1990s and 2000s – crooked privatisations and the rise of the oligarchs under Yeltsin, the re-emergence of state corporations and the dismemberment of Yukos under Putin – were part of a traumatic weakening of state capacity after 1991, followed by a recovery in the new century. Oil has been the key battleground in the contest between state power and private wealth, and a crucial resource for the reassertion of state prerogatives, thanks to high global prices between 1999 and 2008. In Gustafson’s telling, the oil sector offers a typical example of the way Russian capitalism took shape through a combination of adaptation, improvisation and compromise with the remains of the Soviet system.

The Soviet oil industry was organised on a completely different basis from most others. Instead of vertically integrated companies, linking extraction, transportation, refinement and trade, the various processes were separated out: the ‘upstream’ was run by ‘production associations’ answering to the Oil Ministry, while the ‘midstream’ refineries came under the Ministry of Oil Refining and Petrochemicals; exports were handled by another body within the Ministry of Foreign Trade. During the Soviet collapse this system turned into a jumble of disconnected entities, and the next decade brought a ruthless struggle over the reorganisation of the pieces and who would own what. The Yeltsin government’s desire to create a layer of private property owners was decisive: in November 1992, Yeltsin signed a decree that created three new vertically integrated oil companies which were 55 per cent private at the start. LUKoil, Yukos and Surgutneftegas, all based in West Siberia, dominated the landscape for the next decade, turning their main shareholders into multimillionaires. The remaining pieces of the oil industry were parked in a residual state company, Rosneft, and were supposed to be sold off after three years.

In the first half of the 1990s, the industry continued to fragment as oilmen and, increasingly, bankers peeled off state assets, producing a bewildering array of companies. (The two major exceptions to the centrifugal rule were the Soviet gas monopoly, Gazprom, which remains intact to this day, and the oil pipeline monopoly, Transneft.) By 1995, the three majors had successfully consolidated themselves as private entities thanks to carefully managed share auctions; Vladimir Bogdanov, head of Surgutneftegas, managed to sell the entire company to himself by shutting the local airport for the day: he literally excluded all other bidders. The largest private companies gradually extended their reach: by 2002, the state-owned sector’s share in production was down to 20 per cent, and half of private production was controlled by a handful of oligarchs.

The power of private wealth in Russia had been spectacularly confirmed by the infamous ‘loans-for-shares’ deal of 1995, in which Yeltsin’s government handed stakes in valuable companies to the oligarchs in exchange for cash to fund the president’s re-election campaign. Among the oligarchs was Mikhail Khodorkovsky, who gained control of Yukos for $303 million in late 1995; within a few months its market value was more than $3 billion. Whereas Bogdanov and Vagit Alekperov, the CEO of LUKoil, had spent their working lives in the oilfields, Khodorkovsky was a product of the late Soviet turn to the market: a Komsomol activist turned banker whose lodestars were cash flow and share price. His importation of Western personnel and technology made him enormously wealthy in the short term, but it also set him apart within the world of Russian oilmen: the neftianiki were mainly engineers and geologists by training, who aimed to maximise output over the lifespan of a reservoir rather than pushing hard for immediate returns. Khodorkovsky was not only more aggressive in his pursuit of value – he was happy to lay off workers, avoid taxes and cut off social subsidies to local communities – he also impinged on the prerogatives of the state, planning his own pipeline to China and, at the end, attempting a merger with Chevron.

Gustafson carefully sifts through a number of explanations for Khodorkovsky’s downfall, finally deciding that it was ‘the totality of his actions’ rather than any single factor that decided his fate. But perhaps the miscalculation that underpinned all the others was his mistaken sense of the role and power of the state. Gustafson explains that Khodorkovsky ‘had grown used to dealing with a state that was malleable, in which officials could be co-opted, intimidated or bought’. At one point his man on the Duma’s tax committee actually took instructions from Yukos headquarters over the phone during a parliamentary session. Khodorkovsky’s Russia was one ‘in which coercion had disappeared, and in which foreign governments, corporations and banks were alternative sources of power and protection’. What he and the other oligarchs had not understood – and what veterans like Bogdanov and Alekperov on the contrary never lost sight of – was that ‘the state’s coercive power had not been broken in the 1990s, only suspended.’

Khodorkovsky’s arrest in October 2003 on the tarmac at Novosibirsk airport and the subsequent expropriation of Yukos provided dramatic confirmation of the revival of state capacity after the decline of the 1990s, which had culminated in the rouble crash and default of 1998. Devaluation that August gave a boost to domestic industry, but most important, after remaining low for most of the decade, global oil prices began to climb again in 1999. The price of Russia’s Urals export blend rose from $12 per barrel in 1998 to $24 in 2002 and $51 in 2005. As a result, oil production began to recover too, as energies that had been focused on battles for ownership and control instead turned to investment. Between 1998 and 2004, output increased by 50 per cent, from 304 million tons to 459 million, and exports almost doubled. This provided the revenue that funded Putin’s drive to reassert state authority and enabled him to secure popular support by, among other things, paying the pension and wage arrears that had built up under Yeltsin. It was the oil boom of the ‘zero years’, as the 2000s are called in Russia, that ‘set the stage for a massive confrontation between the private oil industry and the state’. As Gustafson explains, ‘without the increase in oil revenues that began in 1999, the political stakes would arguably not have been so high, the ambitions of the private sector so great, and the response of the state so determined.’

The Yukos affair sealed the transition to a new configuration in Russian oil. Now it was the state company, Rosneft, that would play the leading role. Though this was widely presented as a sinister development, Gustafson observes that it merely brought Russia into line with the current global norm: national oil companies, from Saudi Arabia to Venezuela and from Angola to Norway, today control three-quarters of the world’s proven reserves; it is only in the US that private concerns dominate. Intended on its creation in 1992 to operate for only three years, Rosneft was initially ‘more an assemblage of lifeboats than a company’; most of its assets were picked off in the early 1990s, and it only just survived repeated attempts to put it up for auction – the last deferred thanks to the 1998 rouble crisis. In 2004, Putin started the process of merging it with Gazprom to form a gargantuan national energy company, but the aftermath of the Yukos affair put paid to this: Rosneft was the only company that could swallow Yukos’s assets without fear of sanction from courts or shareholders abroad. The result, as Gustafson makes clear, is a typical post-Soviet hybrid, combining elements from the USSR’s Ministry of Oil with employees and management techniques transplanted from Yukos.

The high point of Putinism was 2008. By then, oil revenues had enabled Russia to accumulate $550 billion in gold and foreign exchange reserves, the third largest in the world after Japan and China, and $180 billion in two sovereign funds. In April that year, Dmitri Medvedev was designated Putin’s successor, and in July oil prices reached $147 a barrel. The future of the system the Kremlin called ‘sovereign democracy’ seemed assured: the invasion in August of Georgia, a US ally aspiring to Nato membership, was the measure of its confidence. But the Kremlin hadn’t reckoned with the effects of the financial crisis which struck Wall Street that September. Russian private-sector companies had loaded themselves with debt in the preceding years, and the loans were now suddenly called in, sucking funds out of the country. Meanwhile, the price of benchmark Brent Crude plummeted, reaching $33 a barrel by mid-December. The economic downturn in Russia was dramatic: in 2008 there was 6 per cent GDP growth, in 2009 an 8 per cent contraction – the worst slump in the G20. Oil prices rose again during 2009, reaching $70 in the summer, but over the year the Russian government spent 13 per cent of GDP, including a sizeable chunk of its currency reserves, bailing out private-sector firms and propping up the value of the rouble. The global financial crisis ushered in a third phase in post-Soviet Russian capitalism, after the privatisation drive of the 1990s and the return of the state in the 2000s. Exposure to the winds of global finance has made the Russian government less stridently confident in its model, yet the state-business elite forged in the zero years remains reluctant to surrender its gains – especially given the continued high price of oil.

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The bonanza can’t last indefinitely. Gustafson observes that the Russian oil industry relies, to a degree that is unusual in international terms, on its ‘brownfields’ – fields that entered production decades ago. The boom of the 2000s had less to do with the energies of new entrepreneurs than with the accumulated inheritance of the Soviet era: fields, pipelines, geological knowledge and drilling techniques remain largely the same. The surge in production since the late 1990s seems impressive only because of the slump that immediately preceded it; Russian oil output has not matched its 1987 peak even today. In Gustafson’s view, ‘the Soviet legacy assets have acted as an anaesthetic, delaying the adaptation of the Russian oil industry to modern management and technology, allowing it to remain relatively isolated and poorly equipped to compete globally.’ Post-Soviet oil companies have done relatively little exploration of their own: most of the fields brought online since 1991 were found by Soviet geologists, and only one major new field discovered since 1988 has entered production – Vankor, in the far north of the Krasnoyarsk region, operated by Rosneft since 2009.

The combination of high oil prices and a massive expansion of production that proved so beneficial to Putin is ‘not simply unlikely to happen again – it is impossible.’ Russia’s geological luck is running out: West Siberia’s fields, which today account for almost two-thirds of total production, began to decline in 2007, and new sources of petroleum have yet to be found in sufficient quantities to make up the shortfall. Though there are territories that haven’t yet been fully explored, the prospects for more oil aren’t bright. Gustafson describes the vast, trackless expanse of East Siberia as ‘an oilman’s nightmare’: much of it is coated in ‘thick shields of lava’ from ancient volcanoes, and any fields found here are likely to be deeper, smaller and more dispersed than those in the Ob basin. The hopes of the Russian oil industry are increasingly focused on the offshore ‘bluefields’ of the Arctic and Sakhalin, but these require huge levels of capital investment as well as forms of expertise the Russian companies generally lack. Hence the series of partnerships Rosneft has recently formed with international oil companies: with ExxonMobil and Eni last April, with Norway’s Statoil in August and with BP in October, all of them geared to joint explorations of the Arctic shelf in the Barents and Kara Seas.

Even if the oil industry’s opening to outside investors and technologies is successful, petroleum is likely to occupy a diminishing share of Russia’s exports. A good part of the slack will be taken up by gas. In the Soviet period, there was a broad division of labour between oil and gas: oil was destined to earn hard currency abroad, gas was predominantly for domestic consumption. Since the late 1990s, however, Gazprom has increasingly pursued exports, above all to Western Europe, earning vast sums. Last year it was the world’s ninth-largest energy company by market capitalisation (Rosneft is 12th). Gazprom too is seeking to develop prospects in the Arctic, where climate change is making colossal reserves of fossil methane newly accessible. But here again, supplies are finite, and a shift from oil to gas does nothing to address the question of over-reliance on hydrocarbon exports. The ‘shale revolution’ in the US has made the question all the more pressing, since the huge increase in supply from unconventional sources is likely to lower prices as well as offering Russia’s European customers a politically more congenial provider.

Diversifying the economy away from oil and gas remains an obligatory rhetorical goal for the Russian elite as a whole. In September 2009, Medvedev – he was then president – described the country’s dependence on hydrocarbons as ‘humiliating’; in his most recent state of the nation address to the Duma, Putin insisted that ‘we cannot put up with the Russian budget and social sector being kept hostage by financial and resource markets.’ What underpins such thinking is the fear that the country might be suffering from some variety of ‘resource curse’. How far does Russia fit the diagnosis? There are three main forms the curse can take. First, there is the ‘Dutch disease’, in which a flood of export revenues from natural resources causes currency appreciation, making other sectors uncompetitive. This has certainly afflicted the rouble, among other things helping to make Moscow one of the most expensive cities on the planet. Second, the volatility of crude prices may have a destabilising effect on the budget, leaving swathes of economic activity prone to dramatic boom and bust cycles. In Russia, as much as 30 per cent of GDP is tied to the fate of the resource sector, and oil now accounts for around half of Russia’s export income and more than a third of government revenues. But this is low compared to the figures in the petro-states of the Middle East: at least 70 per cent of the budget in Bahrain, Kuwait and Saudi Arabia comes from hydrocarbons. The size of the population also makes a big difference: in per capita terms, Russia’s oil revenues are nowhere near as plentiful as those of the Gulf States – $2000 per person in 2009, compared to $25,000 in Qatar.

The ‘resource curse’ literature also identifies, third, a more diffuse set of political symptoms: corruption, as well as a tendency for petroleum revenues to erode democratic accountability and fuel civil wars. Russia’s oil revenues have made corruption possible on a vast scale. But the other aspects of the pathology apply to a much smaller extent – principally because they occur in weak states with little industry. Russia industrialised in the 1930s, and many of its recent troubles stem not from oil but from the crises that followed the USSR’s collapse.

In Gustafson’s view, ‘the tight intertwining of oil and politics’ in Russia is ‘a phenomenon of the final Soviet decade and the post-Soviet transition’; the USSR ‘was not a petro-state, but post-Soviet Russia is increasingly taking on the characteristics of one.’ To avoid this outcome, he recommends not only opening up to outside investors and technologies but also further doses of liberalisation across the economy as a whole. This last remedy seems doubtful, given that by Gustafson’s own account the last major round of liberalisation in Russia coincided with, and exacerbated, a disastrous weakening of state capacity. Besides, the period of maximum private ownership in the oil industry was also the time when the least was done to provide for the future.

It would be misleading, though, to draw a sharp distinction between private and state ownership. What Wheel of Fortune describes is not so much the displacement of private companies by a state-led model as the creation of a new hybrid form. Rosneft may be a giant state corporation, but it is listed on the London Stock Exchange and competes with other state companies – notably Gazprom – like a private concern. Conversely, LUKoil and Surgutneftegas may be privately owned, but they respond obligingly to political directives from Moscow: the former has worked to bolster the Kremlin’s foreign policy stance in the Caspian, the latter has fronted the cash for Rosneft to buy Yukos’s production arm. This blurring of the personnel, motivations and strategic orientations of state and private sectors is the hallmark of contemporary Russian capitalism. No one reading this book could think the Soviet system is simply being re-created under Putin: the most likely outcome of another round of privatisations, it suggests, is a concerted attempt by the state-business elite to turn the companies it controls into private property.